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Key Accounting Terms

By Yann, published on 07/12/2018 We Love Prof > Professional Development > Accounting > Identifying the Most Commonly Used Accounting Terms

“Accounting is the language of business.” -Warren Buffett

Accountants are indispensable in today’s world. The regular tasks that accounting professionals accomplish are essential in the business and finance sector.

Without the careful guidance of hardworking accountants, business owners and executives at corporations would be left to do their taxes, financial records and invoices.

For many, the daily chores of an accountant are tedious, unimaginative and merely dull. However, this is not the case! Accountants complete many intriguing duties on a regular basis that keep work varied and learning more about all the accounting basics can be done by anyone!

Due to the fact that London has been deemed one of the world’s leading financial cities, there is plenty of employment for newly trained accountants. 

Whether you are an aspiring accountant who wants to acquire the basic accounting lingo before taking professional courses or a curious individual intending to learn more about the fundamentals of the accounting profession, Superprof is here to educate readers about the definitions of the most commonly used accounting terms.

Assets

Every profitable company has a significant number of assets. Resources that have future economic value and can later be measured in dollars, euros or pounds are considered assets.

It is important to note that expenses are entirely different from assets. For example, a cost is paying for the company’s consumption of electricity whereas an asset is buying a useful machine that the business will use for the next 10-15 years. The helpful tool will be utilised through multiple future periods and not just once like an electrical bill.

Businesses usually separate short-term from long-term assets on financial documents. The following are examples of short-term assets:

  • Cash,
  • Prepaid expenses.

A few cases of long-term assets include the following:

  • Land,
  • Buildings,
  • Company Supplies,
  • Furniture.

The most valuable long-term assets are pieces of land and real estate that usually appreciate rather than depreciate. Items such as furniture have long-term value but can rarely be sold after use for more than it was bought.

Assets are mostly tangible. Nevertheless, various assets are considered intangible such as licenses, copyrights, patents and customer lists. 

Resources or assets are not only possessed by businesses or corporations but by individuals. For example, a person may have a wide variety of assets that are in constant use and may be sold or leased to make a profit.

Balance Sheets

work of an accountant Accountants are experts at analyzing and creating balance sheets for big or small businesses. (Source: pixabay)

A balance sheet is a snapshot used by the grand majority of businesses that represents the state of a company’s finances at that specific moment in time.

Balance sheets should be filled out every month and compared with each other to get a sense in what areas a company needs to improve. It is a great way to verify the overall health of a small business or corporation.

A balance sheet can be calculated using a simple equation where the assets are on one side, and the company’s liabilities or shareholder’s equity is situated on the other. The equation is as follows:

Assets =Liabilities + Shareholders’ Equity

The company has to pay for all the things it owns or assets it has using by taking on liabilities or issuing shareholders’ equity. 

As we previously mentioned a company’s assets may be cash, marketable securities, inventory and prepaid expenses.

Liabilities are different since it is the money that a company owes to outside parties such as rent, tax, utilities, wages to pay employees and long-term debt. Current liabilities are paid within in the year whereas long-term ones are paid after a year.

Shareholders’ equity is also known as “net assets” and is the money attributable to a business’ shareholders or owners.

For those who are visual and need an image to understand the subject at hand fully, there are many balance sheets from major companies that can be observed online.

General Ledger

A general ledger provides a complete and in-depth record of all financial transactions over the entire life of a large corporation, small business or family-owned company.

The ledger is essential to create financial statements. It also includes accounts for assets, liabilities, owner’s equity, revenues and expenses. A trial balance can additionally validate credit and debit account records.

Accountants use a general ledger to create the firm’s financial statements. Every single financial transaction is posted to the general ledger accounts, and the accountant generates a trial balance. Adjusted trial balances are used to create financial statements.

It is important to note that not all businesses or accountants use a general ledger. With that being said, it can be observed in companies that use the double-entry bookkeeping method. This effective method means that each financial transaction affects at least two ledger accounts and each entry has a debit and credit transaction.

Balance sheets and income statement transactions are also factored into a general ledger to have a further understanding of a company’s financial dealings.

Credits & Debits

spending money While most people living in the Western World possess a debit or credit card, debits and credits in the world of accounting are quite different. (Source: pixabay)

Outside the world of accounting, many people believe that they are familiar with credits and debits.

For example, we possess debit cards and are accustomed to the fact that debits are sums of money that are drawn from our bank account and we have lines of credit that help us quickly understand that credits are amounts of money that can be spent or borrowed from the bank.

However, it is important to note that in the sectors of accounting, business and finance, the role of credits and debits is entirely different. In double-entry bookkeeping, accountants thoroughly understand the difference between the two to keep track of all the business transactions.

Every single business transaction is tracked as either a credit or a debit, and an account ledger requires both. On a double-entry sheet, debits are always on the left and credits are consistently on the right. The account where the money is coming from is credited on the right-hand side, and the money where the transaction is going is debited on the left-hand side.

Here’s a valuable accountant fact, for a ledger to be unfailingly valid, the totals debits on the left side must be equal to the total amount of credits on the right side. 

As we have previously seen, debits and credits have their unique characteristics and are separately used to strengthen distinct kinds of accounts. The following types of accounts are increased by a debit:

  • Dividends or draws,
  • Expenses,
  • Assets,
  • Losses.

Now for credit, it generally increases the following types of accounts:

  • Gains,
  • Income,
  • Revenues,
  • Liabilities,
  • Stockholders’ Equity.

The examples mentioned above are how different kinds of accounts can be increased, but how can they be decreased? Well, the answer is quite simple, oppositely completing the transaction. For example, an asset account is supplemented with debit but decreased with credit.

In double-entry bookkeeping, it is common to see accountants abbreviate debit as dr. and credit as cr.

Revenue

money, money, money All business owners want their company to thrive and generate lots of revenue. (Source: pixabay)

Lots of revenue is always great news for big or small business owners. Revenue can be defined as the sum of money that a company receives in a certain period. This amount of money includes discounts and deductions for the merchandise that was returned.

It is the gross income figure from which expenses are subtracted to determine the net income of a corporation or business. 

Accountants or budding finance students can calculate revenue by multiplying the price at which services or goods are sold by the number of units or amount sold. It can also be known as sales on a financial statement or document.

Depending on the company or the accountant, revenue can be calculated when the goods have been sent to the customer or when payment has officially been received.

Keeping track of revenue and net income is essential for a business to grow. If accountants or financial advisors realise that revenue has been stagnant in the past months, expenses will be cut to increase net income and keep investors happy. However, this should not be viewed as a permanent solution because, in the long run, it could be detrimental to the company.

In the case of the government and non-profit organisations, the net income or revenue is often calculated differently. 

Capital

Generally, capital refers to any financial resources or assets that are owned by a particular business or company. They are instrumental in furthering development and generating income.

However, it is important to note that capital can have different definitions such as funds raised to support a business, the accumulated wealth of a company and ownership in a particular industry. 

Money and capital are entirely different. For example, money is used for transactions and has a more immediate purpose. In contrast, capital includes assets such as stocks or investments that have a more long-term benefit to the future of the company. Money is necessary but is spent very quickly, whereas capital is more durable and requires time to attain but helps the business prosper in the long run.

Capital can also include land and real estate such as factories or other manufacturing warehouses that can be used for the creation of goods or be rented out annually to create wealth that will benefit the company. 

A common term that can be heard by many individuals is capital gains. What does it mean? Capital gains increase in the value of the stock when they are sold. Many other capital-based terms can be discovered and learnt

Cash Flow

This key accounting term can be understood as the revenue or expense expected to be generated through various business activities such as sales and manufacturing over a period a time.

For accountants, cash flow is the difference between the amount of money available at the beginning of a period or opening balance and the total amount at the end or in other words closing balance. 

Every business owner dreams of continually having a positive cash flow, which is when the closing balance is higher than the opening balance. If this does not occur, it is called a negative cash flow.

It is important to note that high levels of cash flow do not mean higher profits or improved performance. In addition, analysing cash flow is not the most effective way of determining the overall health of your business.

However, some practical ways are suggested by accountants to improve the cash flow of a business or corporation. Here are some of the best tips:

  • Selling more goods or offering additional services,
  • Sell assets that are no longer needed by the company,
  • Cutting unnecessary costs,
  • After confidence in the product and a stable client base have been established, business owners should strongly consider raising the price of their products,
  • Collecting money faster,
  • Paying slower,
  • Bringing in more equity and perhaps taking a loan.

Cash flow is usually calculated after a specific reporting period such as a month, quarter or year. Cash inflows can come into a company from the following sources:

  • Operations: cash paid by customers for the goods sold or services offered,
  • Financing Activities: an example of this could be a debt incurred by the entity,
  • Investment Activities: a typical example of this might be the monetary gain from invested funds.

The world of accounting is quite varied and to become one the best working in the business & finance sector, it is essential to continually hone your skills and keep up to date with important accounting terms.

Superprof is here to help interested ones acquire more knowledge about all things accounting such as the key accounting concepts, different types of accounting software and how to correctly read a profit and loss statement.

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