To run a business effectively one has to become familiar with accounting on some level. You are by no means required to understand accounting to the level of a chartered accountant but there are things you need to understand. It would be unfortunate, to say the least, if one where to handed the accounts of their business and failed to make heads or tails of the numbers placed before their eyes. Similarly conversing with bankers, investors and other financially inclined stakeholders without being conversant in certain concepts would not work favourably for a business person. So here are accounting terms you should know the meaning of as a person in the business.
This is a system of accounting that records concepts like income and expenditure when money exchanges hands between parties rather than when the agreement or exchange of goods or services takes place. For the uninitiated, this may seem like the only way business works but there is also accrual accounting.
Accrual accounting records items when the obligation is created rather than when money exchanges hands. Consider a credit sale, the agreement occurs before payment is made. In cash basis accounting the sale is recorded when payment is made whereas in accrual basis accounting the sale is recorded when the agreement is created with payment being treated as receivable to the seller. Accrual accounting is used to match financial transactions with their corresponding activities.
Assets are resources owned or controlled by a business that are used in the production of income or held for some expected future financial benefit. Assets include immovable property, moveable property and intellectual property. You can read more about assets here.
Fixed (Non-current) assets
Of course, there is a distinction drawn between assets. Fixed assets are assets as per the above definition that are expected to be used for a period longer than 12 months.
Current assets are those assets that are expected to be used within 12 months and include inventory (stock), cash and cash equivalents.
Liabilities are present and future obligations that a business is expected to settle.
Capital is the initial investment in a business in cash or other assets plus the residual value of the business after settling all obligations. It is what the business owners are entitled to and hence the value of the business.
Working capital is distinct from capital in that it is the total of cash and cash equivalents (for example debtors who owe the business money)that are at the disposal of the business for funding day to day operations. You can read more about working capita;l in-depth here.
Depreciation is an accounting measure of the reduction in value of non-current (fixed) assets that occurs due to usage, time, obsolescence or other factors that reduce its ability to perform its function now or in the future
Dividends are cash distributions made by companies to the owners of the company (shareholders).
The more popular terminology in modern times is accounts receivable which explains what debtors are perfectly. They are entities that owe the business money from trade which we expect to be settled.
Creditors or accounts payable are entities the business owes money through trade or supply relationships.
When it becomes evident that it may no longer be reasonable to expect a debtor to honour their debt it becomes a bad debt.
Gross profit is simply the profit calculated when we remove the costs that are directly associated with providing products from the revenue we receive for the products. This may sometimes be referred to as gross margin or margin.
Net profit is arrived at by further subtracting from gross profit expenses associated with running the business that cannot be directly associated with providing products. You may see this referred to as net margin.
Are there any terms that you’ve come across that have been left out here? Kindly mention them in the comments and we will gladly explain them in very simple terms.