Small Business: Common Accounting Terms

Most business owners don’t necessarily have to have an accounting degree in order to run a business but knowing some common accounting terms will help with communication within your team and third-party individuals who you will most likely encounter during your business’s lifespan.

Familiarize yourself with these common accounting terms as these will now be part of your daily vocabulary as a small business owner.

Accounts receivable (AR)
The amount of money owed by customers or clients to a business after goods or services have been delivered and/or used.

Accounting (ACCG)
A systematic way of recording and reporting financial transactions for a business or organization.

Accounts payable (AP)
The amount of money a company owes creditors (suppliers, etc.) in return for goods and/or services they have delivered.

Assets (fixed and current) (FA, CA)
Current assets (CA) are those that will be converted to cash within one year. Typically, this could be cash, inventory or accounts receivable. Fixed assets (FA) are long-term and will likely provide benefits to a company for more than one year, such as a real estate, land or major machinery.

Asset classes
An asset class is a group of securities that behaves similarly in the marketplace. The three main asset classes are equities or stocks, fixed income or bonds, and cash equivalents or money market instruments.

Balance sheet (BS)
A financial report that summarizes a company’s assets (what it owns), liabilities (what it owes) and owner or shareholder equity, at a given time.

Capital (CAP)
A financial asset or the value of a financial asset, such as cash or goods. Working capital is calculated by taking your current assets subtracted from current liabilities—basically the money or assets an organization can put to work.

Cash flow (CF)
The revenue or expense expected to be generated through business activities (sales, manufacturing, etc.) over a period of time.

Certified public accountant (CPA)
A designation given to an accountant who has passed a standardized CPA exam and met government-mandated work experience and educational requirements to become a CPA.

Cost of goods sold (COGS)
The direct expenses related to producing the goods sold by a business. The formula for calculating this will depend on what is being produced, but as an example, this may include the cost of the raw materials (parts) and the amount of employee labor used in production.

Credit (CR)
An accounting entry that may either decrease assets or increase liabilities and equity on the company’s balance sheet, depending on the transaction. When using the double-entry accounting method there will be two recorded entries for every transaction: A credit and a debit.

Debit (DR)
An accounting entry where there is either an increase in assets or a decrease in liabilities on a company’s balance sheet.

Diversification
The process of allocating or spreading capital investments into varied assets to avoid over-exposure to risk.

Enrolled agent (EA)
A tax professional who represents taxpayers in matters where they are dealing with the Internal Revenue Service (IRS).

Expenses (fixed, variable, accrued, operation)
The fixed, variable, accrued or day-to-day costs that a business may incur through its operations.

Fixed expenses (FE): payments like rent that will happen in a regularly scheduled cadence.
Variable expenses (VE): expenses, like labor costs, that may change in a given time period.
Accrued expense (AE): an incurred expense that hasn’t been paid yet.
Operation expenses (OE): business expenditures not directly associated with the production of goods or services—for example, advertising costs, property taxes or insurance expenditures.

Equity and owner’s equity (OE)
In the most general sense, equity is assets minus liabilities. An owner’s equity is typically explained in terms of the percentage of stock a person has ownership interest in the company. The owners of the stock are known as shareholders.

Insolvency
A state where an individual or organization can no longer meet financial obligations with lender(s) when their debts come due.

Generally accepted accounting principles (GAAP)
A set of rules and guidelines developed by the accounting industry for companies to follow when reporting financial data. Following these rules is especially critical for all publicly traded companies.

General ledger (GL)
A complete record of the financial transactions over the life of a company.

Trial balance
A business document in which all ledgers are compiled into debit and credit columns in order to ensure a company’s bookkeeping system is mathematically correct.

Liabilities (current and long-term)
A company’s debts or financial obligations incurred during business operations. Current liabilities (CL) are those debts that are payable within a year, such as a debt to suppliers. Long-term liabilities (LTL) are typically payable over a period of time greater than one year. An example of a long-term liability would be a multi-year mortgage for office space.

Limited liability company (LLC)
An LLC is a corporate structure where members cannot be held accountable for the company’s debts or liabilities. This can shield business owners from losing their entire life savings if, for example, someone were to sue the company.

Net income (NI)
A company’s total earnings, also called net profit. Net income is calculated by subtracting total expenses from total revenues.

Present value (PV)
The current value of a future sum of money based on a specific rate of return. Present value helps us understand how receiving $100 now is worth more than receiving $100 a year from now, as money in hand now has the ability to be invested at a higher rate of return. See an example of the time value of money here.

Profit and loss statement (P&L)
A financial statement that is used to summarize a company’s performance and financial position by reviewing revenues, costs and expenses during a specific period of time, such as quarterly or annually.

Return on investment (ROI)
A measure used to evaluate the financial performance relative to the amount of money that was invested. The ROI is calculated by dividing the net profit by the cost of the investment. The result is often expressed as a percentage. See an example here.

Individual retirement account (IRA, Roth IRA)
IRAs are savings vehicles for retirement. A traditional IRA allows individuals to direct pre-tax dollars toward investments that can grow tax-deferred, meaning no capital gains or dividend income is taxed until it is withdrawn, and, in most cases, it’s tax deductible. Roth IRAs are not tax-deductible; however, eligible distributions are tax-free, so as the money grows, it is not subject to taxes upon withdrawals.

401K & Roth 401K
A 401K is a savings vehicle that allows an employee to defer some of their compensation into an investment-based retirement account. The deferred money is usually not subject to tax until it is withdrawn; however, an employee with a Roth 401K can make contributions after taxes. Additionally, some employers choose to match the contributions made by their employees up to a certain percentage.

Subchapter S corporation (S-CORP)
A form of corporation (that meets specific IRS requirements) and has the benefit of being taxed as a partnership versus being subject to the “double taxation” of dividends with public companies.

Bonds and coupons (B&C)
A bond is a form of debt investment and is considered a fixed income security. An investor, whether an individual, company, municipality or government, loans money to an entity with the promise of receiving their money back plus interest. The “coupon” is the annual interest rate paid on a bond.

Callie Malvik “30 Basic Accounting Terms, Acronyms and Abbreviations Students Should Know.” May 20, 2020

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