Hiring an accountant is widely considered best practice for small business owners. You may think you can’t afford an accountant, but look at how long it would take you to do certain tasks such as invoicing, bank reconciliations, taxes and ask yourself, is that a good use of your time? The answer will undoubtedly be “no”. Delegating financial analysis and reporting doesn’t mean completely checking out of the process each month or quarter. On the contrary, it’s recommended that business owners work closely with their accountants throughout the year to better understand their financial position, and make smart plans for future growth.
Want to increase your accounting knowledge so you can have more informed, insightful discussions with your accountant this quarter?
Start right now, with this list of 6 essential accounting terms for small business owner.
1. Cash Flow
A business’s cash flow is a key factor in its potential for long-term survival and success. A company may have huge revenues, but without the ability to generate cash, it can easily fail. It’s not the profit that highlights the overall fiscal health of a business, but cash flow. Do you have more cash flowing into your business each month than you pay out to cover costs and expenses? If so, your accountant will conclude that you’re “cash flow positive.” If the opposite is true, your cash flow statement will reveal that you’re “cash flow negative.”
Having excess cash on hand means you’re better equipped to keep up with debt, cover unforeseen expenses, and invest in growth opportunities. Your accountant will generate a cash flow statement each quarter to keep tabs on this key performance indicator.
2. Profit and Loss Statement
The profit and loss (P&L) statement (also known as the income statement) is one of the most important documents used by accountants to determine the profitability of your business. The P&L statement lists income as well as expenses over a specific period of time (typically every three months for small businesses). It calculates your all important “bottom line” so you know if you’re operating at a loss or turning a profit.
3. Gross vs Net Profit
Gross profit is what remains when you subtract the cost of goods sold (COGS) or cost of services (COS) from your total revenue. This metric only considers variable costs, that is, costs that go up and down as your sales go up and down. Gross profit can be used to calculate your gross profit margin. This metric is an indication of the financial success and viability of the products or services you sell. Small business owners should always looking to improve their gross profit margins by decreasing their cost of goods sold while increasing sales revenues.
Net profit, on the other hand, drills deeper. Often referred to as the “bottom line”, or “net income” or “net earnings”, net profit is calculated by subtracting a company’s total expenses (including taxes and depreciation) from it’s total revenue thus showing what the company has earned (or lost) in a given period of time.
Gross and net profit are both key for measuring business performance against an industry benchmark and your competitors.
4. Balance Sheet
The balance sheet is one of the other most important documents used by accountants. The balance sheet offers a snapshot of your overall financial position at a particular moment in time. It lists the assets (such as cash, inventory, accounts receivable, and equipment); liabilities (like accounts payable, income tax, and loans); and shareholder capital. In a nutshell, the balance sheet shows what you own, as well as what you owe.
5. Accounts Receivable & Accounts Payable
Simply put, accounts receivable is money your business is owed by customers for goods or services sold. It is considered an asset on your balance sheet. Conversely, accounts payable is money you owe suppliers and any bills you have yet to pay, so it’s listed as a liability on your balance sheet.
6. Bad Debt Expenses
Bad debt happens when you can’t collect payment from your customers. Long term outstanding accounts receivable could be listed on your balance sheet as “bad debts”, and if they’re never collected, may have to be written off to the P&L statement.
And there you have it – 6 key terms to help you build your accounting vocabulary, join the conversation, and empower smarter decision-making.