Business owners are bombarded with different responsibilities, and as a result, learning accounting terms comes last on their to-do list. However, one thing that start-up business owners forget is the importance of knowing how to communicate with the team, especially understanding accounting jargons.
To help get you started, we compiled a list of basic accounting terms and formulas that will help you communicate effectively with your financial team.
14 Most Common Accounting Terms For Business Owners
- Allocation. Allocation is the process of identifying and assigning funds to cost objects. A cost object is any item that you want to fund separately like a research project, a product or a department.
- Cash Flow (CF). Cash flow is the term used to describe the amount of cash coming into and out of the business at any given time. It shows a computation of all the cash collected and money spent on operations and investments.
- General Ledger (GL). General Ledger reflects a complete recording of the company’s financial transactions. It includes information about the business’ capital, assets, expenses and revenues.
- Generally Accepted Accounting Principles (GAAP). These are the set of rules and standards that Certified Public Accountants (CPAs) and businesses must follow when accounting.
- Present Value (PV). Present Value represents the current value of an asset. The concept behind it is the theory that money in the future is less valuable than the amount of cash in hand today.
- Return on Investment (ROI). It is the financial measurement used to evaluate the profitability of a project. It originally refers to the profit (return) a company was making.
- Variable Cost (VC). Variable costs define expenses that change depending on the volume of sales. It can either go up or down based on the company’s production.
- Accrued Expense. These are single accounting expenses that are incurred but are not yet paid.
- Balance Sheet. A balance sheet gives an overview of the company’s financial status. It reflects its assets, liabilities and equities at a specific point in time.
- Book Value. Book Value displays the original value of an asset (not including any depreciation amount).
- Equity. Equity pertains to the amount left after liabilities have been removed.
- Cost of Goods Sold (COGS). This term refers to the expenses that directly relate to the creation of a service. It does not include costs that are needed to run the business.
- Gross Margin. A percentage that represents how profitable a company is after deducting the Cost of Goods Sold.
- Dividends. Dividends refer to the earnings of the company that are distributed to shareholders. Usually, it is the board of directors who determine the dividend amount or percentage.
Five Most Important Accounting Formulas For Your Small Business
Cost of Goods Sold
Knowing how to manually calculate the cost of goods sold by your company is better than not knowing how to do it at all. Its formula is easy to remember too:
Beginning Inventory Value + Purchases of Inventory – Ending Inventory Value = Cost of Goods Sold
Gross Profit and Gross Profit Margin
The difference between your total sales income and cost of goods sold (COGS) is your gross profit:
Total Sales – Cost of Goods Sold (COGS) = Gross Profit
Balance Sheet Equation
Understanding this basic equation can give you a glance at how healthy your business is. Its formula is:
Liabilities (what you owe) + Equity (retained earnings in the business) = Assets (what you own)
Net income measures the profitability of your business. Its formula:
Income – Expenses = Net Income
If you know how to calculate your company’s net income, you will be able to determine if you are spending too much versus your revenue. It depicts how profitable you are, but it does not show the health of your cash flow. It is important to keep in mind that your net income does not equate to your available cash in the bank.
The formula for break even point will help you determine how much you need to sell in order to cover your operating costs. It is not as simple as the other formulas, however, it is one of the most important equations you need to know when running a business. Once you are able to exceed your break even point, that’s the time your business becomes profitable. Its formula is:
Fixed costs / (Sales price per unit – variable cost per unit) = Break-Even Point
Fixed costs are your recurring and predictable expenses. Sales price per unit is the selling price of your product, and variable cost per unit is your cost of goods sold.
Whether you’re having an in-house accountant or outsourcing your accounting functions to firms like CorpXervices, it’s important to be aware of these terms so that you can communicate your instructions and necessities effectively.