For small business owners beginning to grow their enterprise, sometimes background work like bookkeeping may seem daunting at first with its many terms and facets. Even if you decide to hire a bookkeeper to help with accounting needs, it is still imperative that you have a firm understanding of the drivers behind your business finances. Below, we define and discuss 23 necessary bookkeeping terms that every small business owner and operator should know and understand.
1. Accounts Receivable
Accounts receivable (AR) refers to a bookkeeping account that holds the total of all unpaid sales invoices for a business. The unpaid sales invoices show the money owed to the business by a customer or client, listed on the balance sheet as an asset. Many businesses offer credit terms to their customers and accounts receivable represents the balance of money owed to a firm for goods delivered or services rendered but not yet paid for by customers. Once the customer submits payment, their invoice is then removed from this group.
2. Accounts Payable
An accounts payable (AP) is a record of all unpaid bill amounts owed by the business to suppliers, other businesses, and vendors on any given date by a business. On the balance sheet, you will find accounts payable as a liability. Think of this as an IOU to your creditors or suppliers that must be satisfied within a certain time frame to avoid default. Similar to an AR, this is removed from the balance sheet once the bill is paid.
A term found on the balance sheet, an asset refers to any resource or items owned by your business that can be measured and has value. Examples of an asset include the following: cash in bank accounts, cash in a petty cash box, accounts receivables, inventory, land, buildings, vehicles, and equipment. Assets also include prepaid rent.
4. Balance Sheet
A balance sheet report shows the business owners and managers how much equity lies in your business, how many assets your business owns, and what outstanding liabilities your business owes. The balance sheet falls in line with the accounting equation. This is another key financial statement that provides a snapshot of your company’s financial position as at a specific date. Just like taking a family portrait every Christmas and compiling a photo album, you can compare the “pictures” of your business, year to year to identify any changes.
5. Bank Reconciliation
This is the final total of debits and credits must match in order to complete the reconciliation of your accounts. Bank recon is important because it allows you to detect fraud, prevent overdrafts, identify bank errors and forecast cash flow.
6. Break-Even Point
This is the sales volume at which a business can exactly cover its fixed and variable expenses.
7. Cash Flow
The term, “cash flow,” refers to a report of the movement of cash and cash-equivalents (short term, liquid assets such as treasury bills) into and out of your business. Positive cash flow allows your business to meet current obligations, reinvest and plan for future growth. Utilizing a cash flow forecast can help your business estimate the income and expenses for the year ahead. These figures will be based on prior earnings and costs and can help a business work out their sales goals and budget.
Also known as the cost of goods sold or the cost of sales, this metric refers to all expenses directly tied to the sale of products in your inventory. COGS also refer to the cost to your business of any parts or stock that are sold to customers. For a service-oriented business, this additionally represents the cost of manufacturing expenses and services rendered.
9. Days Sales Outstanding
Days sales outstanding measures the average number of days that it takes for accounts receivables to be collected. This is a useful metric to keep a handle on because it impacts cash flow management. The formula is:
(Accounts receivable ÷ Annual revenue) × Number of days in the year
10. Double Entry Bookkeeping
Every transaction affects two accounts: debit and credit. For every debit transaction entered in one account, there must be an equal credit transacted in another. The goal of this bookkeeping strategy is for all the debits to equal the amount of the credits. In the event the two totals do not match, the bookkeeping is out of balance and the error needs to be found and reconciled. As a benefit to this bookkeeping methodology, this allows you to anticipate your cash flow needs as it tracks accounts like inventory, accounts payable or accounts receivable.
Equity is the net assets of a business and is the amount remaining when you subtract your liabilities from your assets: Assets – Liabilities = Equity. In other words, your business is financed by debt obligations (liabilities) and owner investments (equity).
Expenses refers to money spent, or costs incurred to generate sales. Most purchases made by your business are categorized as an expense. These appear on the profit and loss report and can be used to reduce the amount of tax owed to the government. Examples of an expense include wages, utilities, office supplies, and marketing.
13. Fixed costs
As the name suggests, these expenses remain constant regardless of output. Fixed costs, also referred to as capital assets, include the tangible operating assets of a business. An example of a fixed cost is the monthly rent of your building or facility. These assets generally provide the business with operating capacity as opposed to being held for resale. They have a relatively long life.
14. General Ledger
This provides a complete record of all income statement and balance sheet transactions. It helps businesses sort, store, and summarize their company’s transactions. A general ledger represents the formal ledger for a company’s financial statements with debit and credit account records validated by a trial balance.
15. Gross Margin
Gross Margin is the difference between revenue and cost of goods sold, expressed as a percentage. This is an indicator of your business’ ability to cover the remaining expenses outside of the cost of goods sold. One example is the gross profit margin based on sales divided by gross profit, and the result turned into a percentage. Businesses can choose what margins they should have to earn a profit and then decide at what prices their products need to sell at to make this happen.
16. Income Statement
As an income refers to the money earned by a business through the sale of products or services, an income statement outlines your business’ profitability over a period of time. These time periods could consist of a month, quarter, or even a year. For this reason, the income statement is often referred to as the profit & loss (P&L) statement. It shows revenue (sales of goods and services) minus expenses.
Liabilities consist of debts that the company owes to other businesses and includes accounts payable, loans and credit card balances. Think of a liability as the opposite of an asset. These are the obligations of your business — amounts you owe to creditors. Liabilities typically have the word “payable” in their accounting entry. For example- notes payable, accounts payable, interest payables and salary payable.
Liquidity describes how quickly an asset can be converted to cash. Without a good degree of liquidity, your business runs the risk of not being able to pay the bills, or worse case, keep its doors open.
Revenue represents the sales a company earns from providing a service or selling a product. Also known as Sales, this is the first line that appears in the Income Statement.
20. Single Entry Bookkeeping
Single entry bookkeeping records money as it comes in and out of the business in a simple spreadsheet, with one entry for each transaction. This method is recommended for cash businesses or those with a very simple structure and a low volume of activity.
21. Trial Balance
This is a statement of all debits and credits under the double-entry method of bookkeeping.
22. Variable Costs
Variable costs tie to production levels and rise as your sales volumes increase e.g. hiring freelancers to handle an unusually large order.
23. Working Capital
This is the most basic measure of liquidity. It is calculated as follows: Current (short-term) Assets minus Current (short-term) Liabilities.
Bookkeeping the Right Way with RQB
Though it may be easy to feel inundated by the many moving parts involved with bookkeeping, they are imperative to a successful business. Bookkeeping is a critical business function that, if done correctly, consumes a considerable amount of your time away from your core business. However, there are many ways to reconcile your business books hassle-free! If you would like to focus more on strategic, revenue-generating activities, then outsourcing your bookkeeping needs is the wisest solution.
At Remote Quality Bookkeeping, our virtual bookkeeping services help you transfer your bookkeeping tasks to an entire team of experts, allowing you time to grow your business. Additionally, RQB will help customize the scope of work you require and tailor solutions that take into account your budgetary constraints. Leveraging our scalability means you get to save the time – as well as the cost and hassle of hiring an in-house bookkeeping. In turn, you can use the additional efficiencies to gain a competitive edge and effortlessly scale your own business. Contact RQB today to see how we can meet your needs!