In order to know your business numbers, you have to understand what your accountant (or virtual CFO – yep I gave myself a shameless plug haha) is saying! I know what it feels like to sit in a room full of professionals using words and acronyms you’ve never heard before. It’s like they’re speaking a different language. I don’t ever want you to feel that way. In fact, I want you to feel empowered by your financial information. So, here’s my top ten accounting terms to help you out in meetings with your accounting/finance person. If you want to skip past the basics and go straight to a deep dive on accounting terms (including all of these), you can grab a free copy of my cheat sheet here!
1. Journal Entry
A journal entry is the transaction recorded when something financial happens in the business (sale, purchase, payment, etc.). All journal entries have a date, account being debited, account being credited, and amounts. I’ll talk more about debits and credits next. Ideally, each journal entry should include the supporting documents for that transaction (receipt, invoice, calculation spreadsheet etc.). All journal entries have to “balance”. The total amount being debited must equal the amount being credited.
2. Balance Sheet (BS)
The balance sheet is a view of the company’s financial position at a particular point in time. The balance sheet includes what you possess (assets), what you owe (liabilities), and what you own (equity). Like the title implies, a balance sheet should balance. The basic structure of the balance sheet is:
Assets = Liabilities + Equity
Assets are resource the company possesses. An asset does not have to be owned outright. You could still be paying on the asset through a loan. This can be tangible items like cash, inventory, furniture, equipment, buildings, etc. or intangible items like patents, favorable financing agreements, or goodwill.
Liabilities are obligations the company owes to another entity. Some examples of liabilities include accounts payable and debt/loans. Liabilities can be classified as short term or long term like an asset and are grouped on the balance sheet in order of classification.
5. Equity (Owners Equity or Shareholders Equity)
Equity shows the owner and/or shareholder investment in the company. It is the sum of initial investments plus retained earnings (discussed below) less draws or profit distributions. It can also be calculated as assets minus liabilities. As a business owner, you want your equity to stay positive. Negative equity represents a loss of business value.
6. Income Statement/Profit & Loss (P&L) Statement
The income statement is a view of the company’s financial position for a specific period of time. It shows you if you are profitable so far this year (or selected period of time that you are reviewing). The basic structure of the income statement is:
Revenue – Expenses = Net Income (Profit/Loss)
I had to include this juuuuust in case someone doesn’t know. A business’ revenue is all the money your business earns through the sale of goods and services. Revenue can also include lesser known (not necessarily goods/services related) items like interest, asset sales, rental property, etc.
Most of us know what an expense is. But did you know that an expense can be categorized as fixed or variable? All expenses are costs incurred to run your business. A fixed expense or fixed cost is an expense that remains relatively stable in existence and amount every month (e.g. office rent). A variable expense or variable cost is an expense that varies based on production, sales, use, etc. (e.g. a material used in your button making at the button factory).
9. Net Income (NI) (Net Profit/Loss)(Earnings)
Net income is often referred to as the “bottom line” because it is the sum of all revenues minus all expenses. It doesn’t matter what the expense is classified as or related to. Net income is the final total.
This does not mean net income is the most important or only important number for your business. There are many businesses with a positive net income but a cash flow issue. Alternately, a company could have negative net income but a positive gross income meaning their product/service could be individually profitable. Understanding all of the numbers helps us ask the right questions and find the answers to profit maximization. No single number is more important than the big picture.
10. Cash Flow Statement (CFS)
The cash flow statement shows how money moved into and out of the company. Your cash flow statement agrees with the change in cash for the period represented. It categorizes each cash transaction based on its use/activity as operating, financing, or investing for visibility
I hope these definitions help you better understand your business finances and feel more confident in your meetings. I try to be as straight-forward as possible with my clients but some of these terms can’t be avoided. Regardless of who you are working with, you should never be afraid to ask what something means. Numbers are not your zone of genius but they are ours. Questions are encouraged! And remember, these are just the top 10… the basics to get you going. I have a comprehensive cheat sheet of 40+ accounting terms (including the ones listed in this blog) in an easy to reference format.