As accountants, it’s easy to think that all the financial jargon we use is simply common knowledge. Maybe that’s one reason we get forgotten when the party invites go out (It can’t always be blamed on the SPAM filter.)
For small and medium-sized businesses to truly thrive, everyone needs to understand what’s going on and the financial facts need to be explained in plain English. For those times when we just can not avoid technical lingo, we give you a quick rundown of common accounting terms and what they really mean.
Let’s start with this one because it sounds scary if you’re not sure what it means. Don’t worry, no one is keeping two sets of books. Nothing shifty going on here. Double-entry bookkeeping is a system where two or more accounts are impacted by every transaction. This is the best way to reflect the financial realities we’re trying to record.
For example, if you use cash to buy inventory, the Cash account and the Inventory account would both be affected. If you performed a service and invoiced the client, both the Service Revenue and Accounts Receivable accounts would be impacted.
GAAP (pronounced “gap”) stands for Generally Accepted Accounting Principles. This is a set of standard practices U.S. companies use to ensure everyone is on the same page. These principles make financial statements more readable and more comparable for investors and stakeholders by allowing them to compare apples to apples.
Although the US relies on GAAP, most international companies use IFRS (International Financial Reporting Standards).
Once upon a time, there was a physical ledger book where all entries were recorded. Today, the general ledger is typically electronic but it’s still home to the entries made to record each transaction in your double-entry bookkeeping system.
The information in the general ledger is eventually used to create financial statements for reporting purposes.
Journal entries are entries made in the general ledger to record transactions. Many are now automated by accounting software, so most journal entries made today are manual adjusting entries at the end of the month. These entries typically include dollar amounts, the names or numbers of accounts involved, the date, and a description of the transaction for clarity later on.
A petty cash account is a common way to simplify small office expenses. A small amount of cash is kept on hand, under the stewardship of a specified person. When cash is needed to pay a delivery person, pick up food for the office, or replenish small office supplies, this fund can be used to avoid writing a check or sending the company credit card out in the hands of whoever is running the errand.
The balance sheet is one of the major financial statements and one you hear about often. It shows the current ‘balance” of the companies assets and liabilities at a certain point in time. It can be thought of as a snapshot of “what you own and what you owe.”
This is the profit and loss statement, also known as the income statement. It records the revenues and expenses of the company, hopefully showing a profit on the bottom line. Yep, that often mentioned “bottom line” is literally the bottom line of the P&L where net income is shown.
Unlike the balance sheet, which shows the numbers as of a specific date, the P&L reports the revenues and expenses over a specific period of time, usually a month or year.
Cash Flow Statement
The cash flow statement reports how much actual cash went in and out of the company over a certain period. Where the P&L reports revenue earned, the cash flow statement shows only the actual collected cash. Where the P&L shows expenses incurred, the cash flow statement shows only those actual cash payments issued.
It’s crucial to know both the profits and the cash flow of the company to make wise decisions.
Your financials are recorded in one of two ways. The simpler approach, often used by smaller companies, is the cash basis. Cash basis reporting records income and expenses when cash changes hands, rather than when income is earned or expenses are incurred. For instance, if you perform work in August and receive payment in September, a cash basis system would record that income in September, when the cash is actually received.
The accrual basis is the second approach to reporting transactions. In this system, you “accrue” income and expenses by recording them when they substantially occur, even if the money hasn’t changed hands. In the example from above, you would record the earned income in August as revenue and an account receivable. When payment comes in during September, no income will be recorded but the payment will reduce the accounts receivable balance.
Closing the Books
What better way to close out this list than closing the books? The monthly closing process involved reconciling accounts for accuracy, making any adjusting entries to the general ledger, and ensuring that the books are accurate before financial statements are created.