Understanding Accounting Terms

The accounting world is full of an overwhelming amount of financial terminology and abbreviations.  The number of accounting terms can confuse the most astute business owner.

How can you make sure you are meeting all of your legal obligations if you don’t understand what any of it means?

Many business owners will be very familiar with a lot of the accounting terms, but not what they mean.

With that in mind, we have created a quick guide to de-bunk the most popular terms.

A

Account

A formal record that represents a single aspect of the business i.e. money, assets or resources.

Accounts Payable

The amount owed to a business/supplier for goods or services.

Accounting Period

Most accounting periods are calculated on a monthly, quarterly or yearly basis. These periods of time are referred to as an accounting period.

Accounts Receivable

The number of monies due from customers/debtors. This is usually after a sale or service has been made/completed.

Assets

In short, assets are monies and property and equipment that is owned by the business. This is applicable to items without lien or loan. Assets may be items such as equipment that will depreciate over time. They can also be goods that are sold to customers such as stock. This means that company assets may rise and fall, and are subject to change.

Audit

An audit is a process of reviewing financial records in order to verify their accuracy and completeness. Internal auditing is performed by accountants within an organization where they are present. Smaller businesses will have audits carried out by an independent outside party, where they are required to by law, or indeed choose to.

B

Balance Sheet

The company balance sheet exists to monitor the health of a business. It records the basic accounting formula of assets minus liabilities (debts) at a set point in time. This is usually monthly, quarterly or yearly. The Balance Sheet shows important ratios such as debt to equity and current asset to current liabilities (current ratio).

Bankrupt

When an individual or company has greater liabilities or costs than assets they can be declared bankrupt. When this process applies to a limited liability company, the term used is  “insolvent”.

C

Capital

Money invested by a business owner or investors in order to acquire the assets needed to begin operation.

Cash Accounting

This is an accounting method where only amounts paid and received in a period are accounted for, not amounts invoiced. Some small and rental income businesses can choose to operate cash accounting for income tax purposes.

For VAT,  businesses that conduct most of their sales using credit may benefit from using the cash accounting scheme for VAT.

Cash Flow Forecast

The amount of money that is generated by the business throughout a specific accounting period is called cash flow. A cash flow forecast is the predicted cash flow of an upcoming financial period.

D

Dividend

A dividend is a percentage of after-tax profits which are distributed to its shareholders. Most larger companies usually distribute on a quarterly basis. However, smaller companies often distribute dividends at the end of each financial year.

E

Equity

An owners or shareholders share of a company represents their equity. On a balance sheet equity details the stockholders’ investment and retained earnings or losses.

F

Fiscal Year

This means ‘tax year’ which in the UK commences 6th April and ends 5th April each year.

G

General Ledger

The general (or nominal) ledger is where all business transactions are recorded, including sales, purchases and all expenses. This part of the bookkeeping ledger contains all entries for the balance sheet and the Profit & Loss accounts.

Gross Margin/Profit

Gross margin or profit is the baseline of how profitable your business is. It is the amount that the business has made from the total number of sales, before overheads. To calculate gross profit deduct total direct costs from sales – these costs can be anything from the costs of material and supplies to subcontractors and equipment hire.

I

IAS

An abbreviation for “International Accounting Standard.”

K

KPI

Key Performance Indicators are a quantified measurement used to calculate the performance of a business. E.g. increase in sales.

L

LTD

A Limited Liability Company comprises of a business where the liabilities of its owners are limited by how much they have contributed. E.g. an investor who owns 25 ordinary £1 shares in a company is liable for only £25 of its debts.

LLP

Limited Liability Partnership is a general partnership where all of the partners have limited liability status. LLPs are taxed as partnerships but account like companies, filing accounts at Companies House.

Listed Company

A business that has shares available to buy and sell on the Stock Exchange.

Loss

Similar to gross profit a loss is calculated by subtracting total business costs from total sales made.  Where a service or product generates less money than it cost to supply or manufacture it’s called a loss.

M

Management Accounting

The purpose of management accounting is to help business managers make better decisions. This involves creating reports which are tailored to suit the needs of company managers or directors.

Margin

The difference between revenue and expenses.

N

Net

The net worth of an individual or company is usually total assets minus liabilities, similar to a Balance Sheet. For a company, net worth is often referred to as shareholders’ funds.

O

Overheads

Otherwise known as running costs. Overheads are an expense such as staff salaries or rent. Costs associated with production or sales are not included in overheads, they are direct costs.

P

P.A.Y.E

Pay as you earn is a tax system where an employee’s tax and National Insurance contributions are deducted from their earnings by their employer prior to payment.

Private Limited Company

A limited liability company that doesn’t have to offer shares to the public.

Profit and Loss Account

Also known as an income statement. A profit and loss account is a financial statement which shows the revenue, expenses and profit for a set financial period.

R

Revenue

Revenue is the income that a business has accumulated from its normal business activities. This is usually made up of the sale of goods and services. Revenue is also commonly referred to as sales or turnover.

Revenue can also be received from interest, royalties, or other fees. Income and revenue are interchangeable, compromising the total amount of all income collected at one point in time.

S

Self Assessment

A process in which individuals calculate their own income tax, they self assess. A self-assessment tax return is usually filed online on the HMRC website.

Shares

A part of a company is known as a share. After purchasing shares in a business the buyer will then own a percentage of the company.

SME

Small and Medium Enterprises. This is usually defined by a business which employs less than 250 people.

T

Turnover

The income or revenue of a business over a particular period of time. This figure is calculated before any deductions take place.

V

VAT

Value Added Tax is a sales tax used to increase the price of goods which are deemed to not be essential.

W

Working Capital

This is calculated by taking the businesses current assets minus the current liabilities. In most circumstances, working capital is defined as the cash, accounts receivable and stock, minus the accounts payable.

We pride ourselves on our friendly and approachable team. If you need any help navigating your way through bookkeeping, Tax or accounting then get in touch.

We’re always happy to help and there’s nothing we don’t know about accounts.