Even if your accountant takes care of most of the accounting process for your business, you should become familiar with the language so that you can get a better overview of your company and make better daily and long-term decisions.
To get you started, here are eight accounting terms (and their definition) that will be very useful to you in your business career.
A balance sheet is a document that combines all data concerning your business's possessions and debts, on a given date. Your balance sheet presents your assets, liabilities and capital (what you have - what you owe = what your business is worth).
You can imagine your balance sheet as being a snapshot of your business which shows your entire business, on the specific date you chose. This report is very practical for getting a good overview at the end of each month.
An income statement is a report which, as the name suggests, provides you with the results for a given period in order to show your profitability. The report outlines your profile for the given period by subtracting your expenses from your income. With this report you can compare the same period for two different years and compare your data to your budget.
Cash flow allows you to keep track of all your fund disbursements and entries and manage your liquidity, regardless of when the income (or expense) was recognized. The flow adjusts for each entry and disbursement, and it follows your dollars (literally).
When the total fund entries exceed fund disbursements, the flow is positive. When the cash flow remains positive for a long period of time, your business is considered to be in good health. When disbursements exceed fund entries, the cash flow is negative. It is normal for businesses to go through short periods of negative cash flow, but when it lasts for a long time, the company risks running into problems.
In business accounting, depreciation is a method for spreading the cost of an investment (fixed asset) over its useful life. Depreciation does not take into account the actual payment for the investment, only the period during which the business expects to use this investment.
For example, a company obtains a new computer worth $5,000, which it expects to use for five years. Accounting standards obligate the company to allocate this amount on its expenses over the next five years (in the income statement), even if the computer was paid for in full the first year.
A business must often manage several fixed assets at the same time, each one having a different useful life. It is therefore important to obtain a tool that allows you to follow all your investments at the same time.
Prepaid expenses are the fees that you pay for services or goods that you have not yet received. They are considered as assets since, by being paid in advance, you possess this service, even if it has not been fully “consumed”.
The best example of prepaid expenses is your business insurance. When you sign an insurance contract, you pay for the insurance at the beginning, but the service is valid for the next 12 months. These 12 months do not necessarily coincide with your fiscal year, leaving you with a balance at the end of the year.
Accrued expenses are the opposite of prepaid expenses. They are an unpaid expense, an amount that you owe for a service already received in full. In your income statement, these expenses appear as an expense incurred, but not yet paid.
The term work in progress refers to a report which contains the list of billable hours and work that has not yet been billed. This facilitates the management of long-term projects and the management of billing for the project.
Imagine that you accept a contract that lasts for five years. Are you going to wait five years before you recognize your revenues? Of course not! As the project advances, you will have accomplished work that should be invoiced. You can use the work in progress report to follow this progress and your billing. The work in progress report is generally expressed in dollars.
This acronym means earnings before interest, tax, depreciation and amortization and provides the subtotal of your net income. It represents your gross income, including the operating expenses (employee salaries for example) over which you exercise a certain control, but excluding expenses over which you have no control in the short term, such as interest, taxes, depreciation and amortization.
Income - operating expenses = EBITDA
Income - operating expenses - interest, taxes, depreciation and amortization = Net income
Operating expenses are excluded from the EBITDA since managers’ decisions have little impact on them. EBITDA measures a company's ability to generate an operating profit.
Your EBITA could be required if you want to sell your business or apply for a bank loan. It should always be found in your income statement.
Knowing and understanding these terms does not make you an accounting expert, but it can certainly help you in your discussions with your accountant, investors and financial institution and also help you when taking financial decisions.
What's more, your accounting management software is the ideal tool to see all these terms in action and improve your understanding of the various operations essential to the proper functioning of your business. The majority of the above-mentioned reports are completed using specialized software and allow you to closely follow your monthly and annual data.
Are you looking for a solution to manage your accounting? Contact our team of experts to learn more about our many specialized products!Discover Acomba
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