As a small business owner, it can be challenging to manage all aspects of your company. From marketing to sales and everything in between, it can often feel overwhelming.
One of the most critical aspects of running a successful business is keeping accurate financial records.
Bookkeeping is the process of keeping track of your financial transactions, including sales, purchases, payments, and receipts.
Unfortunately, bookkeeping is not always intuitive, and many small business owners struggle to understand the terminology.
In this post, we will explain some common bookkeeping terms that every small business owner should understand.
Accounts Receivable (AR):
Accounts Receivable, or AR, refers to the money that your customers owe you for products or services they have purchased from you.
When a customer buys a product or service, you send them an invoice for payment. The customer then has a certain timeframe to pay the invoice, usually between 30 to 90 days.
The total amount of unpaid invoices still owed to you is considered your accounts receivable balance.
AR represents an asset on the balance sheet and is typically recorded when you issue an invoice.
Monitoring AR helps you maintain healthy cash flow and follow up on overdue payments.
Accounts Payable (AP):
Accounts Payable, or AP, is the opposite of accounts receivable. It refers to the money you owe to your vendors or suppliers for goods or services that your business has purchased.
Accounts payable is calculated by adding up all the unpaid invoices your business has received from your suppliers.
AP is a liability on the balance sheet and is recorded when a bill is received from a supplier.
Managing accounts payable ensures you meet your financial obligations and maintain good relationships with suppliers.
Assets:
Assets are everything your business owns that has monetary value. This includes cash, accounts receivable, inventory, property, and equipment.
Assets are typically categorised as current assets (e.g., cash and accounts receivable) or fixed assets (e.g., property and equipment).
Liabilities:
Liabilities are the financial obligations that your business owes to other parties. This can include accounts payable, loans, and other debts.
Like assets, liabilities can also be classified into current liabilities (e.g., accounts payable) and long-term liabilities (e.g., long-term loans).
Equity:
Equity represents the owner’s interest in the business. It is calculated as assets minus liabilities and can be thought of as the residual interest in the assets of the entity after deducting all its liabilities.
Cash Flow Statement:
A cash flow statement is a financial statement that tracks the flow of cash in and out of a business over a specific period.
Cash flow refers to the movement of money in and out of your business.
Positive cash flow means that you have more money coming in than going out, while negative cash flow means that you’re spending more money than you’re earning.
Positive cash flow is essential for the survival of your business, as it means that you have the funds to pay your bills, salaries, and taxes on time.
Balance Sheet:
A balance sheet is a financial statement that provides a snapshot of your business’s financial health at a specific point in time.
A balance sheet includes the business’s assets, liabilities, and equity.
Assets refer to anything that the business owns and can include cash, property, and inventory.
Liabilities are debts owed by the business, such as loans and accounts payable.
Equity represents the residual value of the business after all liabilities have been paid off.
The balance sheet is important because it helps you understand your business’s financial health by providing a clear picture of what you own and what you owe.
Profit and Loss Statement:
A profit and loss statement (P & L), also known as an income statement, provides an overview of the business’s revenue, expenses, and profits over a period of time, usually a month, quarter, or year.
The statement shows the amount of money that the business has earned and the expenses incurred to generate that revenue. The difference between the two is the net income, also known as the profit or loss (P & L).
The P & L is important because it helps you track your business’s profitability and identify areas where you can cut costs or increase revenue.
General Ledger (GL):
A general ledger is a complete record of all ledger accounts used by a business.
It is essentially a summary of all financial transactions that have occurred and allows business owners to see a snapshot of their current financial situation.
General ledgers can be used to track transactions over a month, quarter, or year, depending on the business’s needs.
Debits and Credits:
Debits and credits are terms used in double-entry bookkeeping to record transactions.
Debits increase assets and expenses while decreasing liabilities and equity, whereas credits do the opposite.
Understanding the difference between debits and credits is fundamental to accurate bookkeeping.
Chart of Accounts:
A chart of accounts is a list of all the accounts in a ledger. It is essentially a roadmap for all the accounts involved in an accounting system.
The chart of accounts typically includes categories such as assets, liabilities, equity, income, and expenses.
The chart of accounts helps businesses quickly see the financial health of their company and make informed decisions.
Accrual Accounting vs. Cash Accounting:
Accrual accounting records revenue and expenses when they are earned or incurred, regardless of when cash changes hands.
Cash accounting records revenue and expenses when cash is received or paid.
Choosing the right accounting method affects how you report your financials and pay taxes.
Understanding basic bookkeeping terms is essential for every small business owner.
Knowing the difference between these different concepts can help business owners make informed decisions about their finances.
Bookkeeping may seem overwhelming at first, but it is a manageable process that can be learned over time.
By following these tips, small businesses can stay on top of their finances and set themselves up for long-term success.
Remember that bookkeeping is a skill that can be learned and refined over time, and there are many resources available to help you on your journey to financial success.
If you ever find yourself in need of professional assistance, consider hiring a qualified bookkeeper or accountant to guide you through the process.
Happy bookkeeping!