If your last conversation with your accountant left you with more questions than answers then it might be time to swot up on some finance jargon. Here you’ll find some of the most common accounting terms that you need to know as a small business owner… you’re welcome!
An accountant is a qualified professional that will review the transactions of your business, usually on an annual basis, file your annual accounts and calculate your tax returns. Business owners are often loathe to part money to pay their accountant, especially as some accounting software companies would have you believe that it’s a piece of cake to do it yourself. Believe me, there’s a reason it takes years to qualify as an accountant! If you get the right accountant they will invariably be able to save you more in taxes than you pay them.
The word “accounts” is often used interchangeably and can have different meanings, depending on the context. For example, if you want someone to “do your accounts”, you could mean that you want someone to file your Annual Accounts and complete your tax returns. This would require an accountant. Alternatively, you might mean that you want someone to keep on top of your transactions on a regular basis. At a basic level this would require the services of a bookkeeper. In between these two lies another type of accounts – Management Accounts. Unlike Annual Accounts, these are financial reports produced periodically for internal use by management.
Also referred to as Payables, Trade Creditors, Creditors Ledger or Bought Ledger, this is a list of all your trade suppliers to whom you owe money at a given point in time.
Also referred to as Receivables, Trade Debtors, Debtors ledger or Sales Ledger, this is a list of all your trade customers who currently owe you money at a given point in time.
In the UK, if your business is a Limited Company, you will be required to file your Annual Accounts (sometimes called Year End Accounts) with Companies House. These are formal reports, which show the current financial condition of the company. They usually comprise of a profit & loss, balance sheet and statement of cashflows. It’s important to make sure your annual accounts are filed well before the deadline as late filing can affect your credit rating as a business. If you operate as a sole trader or partnership it’s still a good idea to produce annual accounts, although you are not required to by law. Maintaining proper records enables you to manage your business, but also provides an audit trail for tax purposes.
The idea of an accrual is to match income to its corresponding expense in the same period. Let’s say you’ve invoiced a customer for work done this month, but you haven’t had the invoice from the supplier for the materials you used to carry out the job. You will need to make an accrual for the expected cost of the materials in the same month, or period, that you completed the work. Accruals are important because they help you get a better idea of your profits in the period.
Amortisation is the gradual reduction in value of an asset or liability over its life. It is very similar to depreciation, but is used for intangible assets.
An asset is something that belongs to the business and has a value. There are different types of assets. Cash in the bank, inventory or customers that owe you money are called current assets because they tend to come in and out of the business more quickly. Items that you are going to use in the business for an ongoing period of time are called fixed assets. Examples of fixed assets are machinery, cars, buildings, office furniture, computer equipment and so on. Something that isn’t necessarily physical is called an intangible asset. An example of this would be goodwill.
Also known as the Statement of Financial Position, the balance sheet is one to the key financial statements of a business. It shows the net worth (assets less liabilities) of a company at a single point in time. Effectively it’s telling you “if everything stopped today, and you sold all your assets and paid off all your liabilities, this is what you’d be left with”.
Quite literally it means “keeping the books”. Before the advent of accounting software, all the transactions of a business were accounted for in books, called ledgers. A busines owner, or his accountant, would gather all his receipts, cheque book stubs (remember them?), and sales information and enter everything into the books. Accounting software is simply a more automated, digital version of these. You still need to know what you’re doing though, and the books won’t keep themselves!
If a cost is referred to as being capital in nature, it means that an item has been purchased which is going to be used in the business on an ongoing basis (eg: machinery, equipment, car). These items are fixed assets and will sit on the balance sheet as something you own that has a value. The cost will then be spread over the life of the asset, rather than hitting the current year profit & loss account in one go.
Cash flow statement
This report shows the movement of cash in and out of a business. It’s important to distinguish your cash flow from your profits. They are not the same thing, although profits do help your cashflow! For example, your profit & loss account will not show you that you have a big VAT bill coming up.
Chart of Accounts
A chart of accounts (COA) is an index of all the accounts and categories that are available to the company for recording its financial transactions.
Someone to whom you owe money. These can be your suppliers, HMRC, or a lender.
Someone who owes you money. The most common form of debtors are your customers.
Depreciation is the means by which the cost of a fixed asset is spread out over its useful life. Let’s say you bought a new PC for £900, and its useful life was 3 years, at which point you’ll need to replace it. Instead of taking the full hit to your P&L in the first year, you instead depreciate the asset over the next 3 years, at £300 each year. The value of the asset in the balance sheet is gradually reduced to NIL, and the cost is fairly spread out over the length of time that you’re going to use it.
Dividends are payments made to the shareholders of a company once the profit for the year has been calculated. For owner managed companies this is an important point. You can’t just pay yourself £1,000 here and there and call it a dividend. You must ensure that your profits can support it, or you will be taking an illegal dividend (cue dramatic DUN DUN DAAAAA sound effect!)
Also referred to as the nominal ledger, this is where all the records of your transactions are held. It contains the same accounts as the Chart of Accounts, but the general ledger shows the monetary values of those accounts (the COA is just a list).
Goodwill is generated where something has been purchased for a value which is more than its component parts. This can occur when another business is being purchased. For example, the balance sheet of a company might show £1m of assets (buildings, debtors, cash etc), but the company has several ongoing contracts which mean the company is worth more than its current balance sheet. Anyone purchasing the company would pay more than the balance sheet value of £1m. If the purchasing company paid £1.2m, £0.2m would be the value of the goodwill.
This is another name for the Profit & Loss account (or P&L)
This is the amount of goods you have in stock that are going to be sold in the day to day activities of the business.
An invoice is a document presented to customers detailing charges to be paid for services or goods provided.
A journal is a transaction made by accountants to post entries into a company’s records.
If an asset is something that a company owns, a liability is something that a company OWES to someone else. It is an obligation to pay something in the future because of an event in the past and is shown on the balance sheet. Some examples of liabilities are bank loans, outstanding supplier bills that you haven’t yet paid, or a VAT bill that you need to pay.
Liquidity a measure of how quickly a business can convert its assets into cash. Something like a debtor is easily converted to cash through recovery of money from the customer. A fixed asset such as a building is not!
Management accounts are financial reports produced for business owners and managers, generally monthly or quarterly. They are normally comprised of a Profit & Loss report and a Balance Sheet, but could include additional reports tailored to the requirements of the business. In principle they are similar to Year End accounts but are less formal and in most cases more detailed.
Just as accruals are used to match income and expenses in the same period, prepayments follow the same principle. The difference here is that a prepayment occurs when you have incurred an expense that relates to a future period or future sale. For example, you have been billed for materials for a job that won’t be invoiced to the customer until next month. In this case you would need to make an adjustment to “prepay” the cost of those materials, holding the cost in the balance sheet until you’re ready to invoice the customer.
Profit & loss Account
Also referred to as the P&L, Profit & Loss statement, income statement or Statement of Comprehensive Income. Where the balance sheet shows you a snapshot at a particular date the P&L account shows the activity over a set period that got you to that point in time. A P&L account captures all income and costs over the period under review. It shows you how well your business has performed, showing a profit or loss at the bottom once everything has been included.
Reconciliation is an accounting process that compares two sets of records to check that figures are correct and in agreement. Account reconciliation also confirms that accounts in the general ledger are consistent, accurate, and complete.
These are the profits of previous periods which have been kept (retained) within the company rather than paid out as dividends.
Also referred to as “the TB”. This is an extract of all ledger accounts at a given date. A trial balance includes everything, all income, expenses, assets and liabilities. And, as the name suggests, it must balance (ie: the sum of all the debit balances must equal the sum of all the credit balances)
This is another name for the total sales made by a company in a specified period. You might also hear the terms “Income”, “Revenue” or “Gross Revenue”. They’re just a different way of saying the same thing. Turnover is an important measure of your performance but it’s important that you don’t get it confused with your profits. If you liken it to your monthly salary, turnover is more like your gross salary, whereas profits are more like your take-home pay.