12 Accounting Terms You Must Know!
You’ve dipped your toe and now it’s time for the big dive! Jumping into the pool of accounting can be a little complex. But as an entrepreneur, there’s no two ways about it. You just have to do it- head on! There are some terms like profit, revenue and liabilities that most people are familiar with, and then there are some that are just a tad bit more complicated. Before you start scratching your head, let us help you make this jump easier. Here’s a quick glimpse of Accounting Terms 101.
- Financial statements
What accounting is made of begins and ends with financial statements i.e., the record of every financial transaction and condition of the company! The standard set of statements includes the balance sheet, the income statement and the cash flow statement. The balance sheet gives an overview of the company’s assets, liabilities and equity at a given time, whereas the income statement gives an overview of expenses, revenues, net income and earnings per share over a range of time. When you merge the two, you get cash flow statements which defines as the records of cash generated and used over a particular period of time. The company’s financial statements are an essential asset when it comes to analyzing the company’s financial future and evaluating its performance.
GAAP – Generally Accepted Accounting Principles are mandatory accounting principles in the United States, standards and procedures that companies are required to follow while making the financial statements. They are the most commonly accepted methods of recording and reporting accounts. GAAP ensure that the financial information is standard and clear for all companies alike.
- Chart of accounts
Chart of Accounts or COA is comprehensive list of all your ledger accounts in the accounting system. Typically, COA serves as the basis of a company’s accounts, assets, liabilities, equity, revenues and expenses. Think of it as your list of expense categories, and then expand that to include your list of revenue categories – and then on to your assets (cash, bank balances) and liabilities (what you owe on credit cards, what you owe to vendors). Without some way to list these activities separately and report on the statements all that useful reporting detail would get lost!!
- Journal entry and ledger
A journal entry is a single entry in the accounting system that affects multiple accounts on the general ledger. Journal entries are used to record manual accounting entries (not downloaded from your bank or credit card or revenue processor) and most often are used in applying accruals, pre-paids, etc. which are critical for preparing accurate accrual-based statements.
An audit is an official verification of a company’s financial records done by an external entity. Auditing also keeps a check on a company’s timeliness and payment of the proper tax due. (Reminder- An audit will be a requirement as your company scales!)
- Convertible Note
A convertible note is a short-term debt instrument intended to convert into equity at a valuation determined by events at a later stage. Convertible notes are a very commonly used instrument by early-stage investors to help finance companies that are still in the ideation and concept development phase.
- Double-entry Accounting
Double entry accounting is the basis of all modern accounting. Each and every transaction in the accounting system applies to two or more accounts, which may be credit or debit accounts. And every transaction must balance: credits equal debits. Hence the term “balance sheet” to check everything is correct! You needn’t worry about this most of the time – any modern accounting system checks for balancing on transaction entry (or at least they should J). Double entry statements always involve two or more accounts and is an essential system to minimize errors. The bookkeeper’s job is to ensure that the final entries are balanced. In simple words, there are always at least two entries involved for every transaction in terms of either assets or liabilities or debit and credit.
- Retained Earnings
Retained earnings refer to the amount of net earnings that are not distributed to the stockholders but are reserved for reinvestment. This amount is mainly retained by the company to invest further in the company’s growth.
The products of a company that are or will be listed for sale are listed under the inventory asset. The inventory is a valuable asset, which includes raw materials, manufacturing supplies or even the final goods. Inventory is reported as a current asset in the company’s balance sheet.
- Bank reconciliation
Bank reconciliation is a method to make sure that the company’s accounting statements are a match to the bank’s balance statements. Though there might be certain differences due to delay in updates, it is fundamentally necessary to perform bank reconciliation to identify errors or discrepancies. (Tip- Perform bank reconciliation frequently, after a set interval of time – ideally monthly! The error tempCFO sees most often with companies is out of date or incorrect bank reconciliations)
- Deferred revenue
Any advance that a company receives from their client or customers before the actual sale or performance of a service is deferred revenue. Basically, revenue earned for a service yet to be provided. This “unearned revenue” is added as a liability on the balance sheet.
- Cash-basis & accrual-basis
Cash basis accounting records revenues when cash is received and expenses when the expense is paid. Simple as that. On the other hand, accrual accounting records earnings and expenses as and when they occur, regardless of when the money is received or paid. Accrual basis is more common and recommended under the GAAP guidelines.
Phew! Yes, learning this terminology can be a bit ‘taxing’, but it is extremely important for any company and business owner to know. We know accounting can be challenging, so if you have any concerns, just shoot us a tweet and we’ll be happy to help!