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Understanding Accounting Terminology

Understanding Accounting Terminology

When you are starting out in your own business, things can seem a bit daunting at times, especially when you visit other professionals that you rely on to assist you, accountants or book-keepers for example, as the terminology that they use can be unfamiliar to you and leave you feeling more confused after speaking to them then you were in the first place. Understanding what your accountant is telling you is pretty vital if your business is to succeed so we have put together a brief "jargon buster" for you to help you with understanding accounting terminology.

  • Assets – There are two types of asset:
    • Current Assets – which are things that more short termed (under a year) that you can easily convert into cash for your business. For instance, Stock, debts to the company, your bank account and short term investments as well as of course, cash itself.

    • Fixed Assets – These are owned by the business and are necessary to create the income to keep the business running and that you will be keeping for a long time and aren’t easily converted in to cash. The sorts of things that are fixed assets are buildings, plant and equipment, vehicles, etc, the cost of these items is broken down and becomes an overhead for the useful life of the asset – which is known as depreciation.

  • Balance Sheet – This is used as a "snapshot" of the state of your business at any given time, it shows the Assets, Liabilities and Owners Equity – these values change regularly and are carried forward from year to year.

  • Credits – These are your income and Sales. These go on the right of a profit and loss (not to be confused with Creditors (see below))

  • Creditors – Suppliers and individuals that the business owes money to.

  • Creditors Days – You work this out by dividing the trade creditors by the cost of sales and then multiplying that by 365 to get the number of days it will take you to pay.

  • Debits – These are the costs to you business and any expenses you incur. These go on the left of a profit and loss (not to be confused with Debtors (see below))

  • Debtors – These are suppliers and individuals that owe the business money.

  • Debtors Days - You work this out by dividing the Debtors by your Turnover and then multiplying that by 365 to get the number of days it will take till you are paid.

  • Expenditure (also referred to as Expenses) – Like your Assets, Expenditure can be split into two categories
    • Direct Costs – This is anything that you purchase directly to produce the products/service you sell. This includes your staff wages as these are classed as labour.

    • Overheads – This figure is made up of anything else you have to pay to keep the business running.

  • Gross Profit – This is the figure you get when you divide the Gross Profit by the sales value.

  • Income – Your income can be broken into two groups:
    • Sales (this can also be referred to as Turnover) – This refers to the money generated from the sale of your goods or services before you take off any percentage for costs or discounts.

    • Other Income – This refers to any money that you receive into the business through interest, discounts, or anything that is not directly related to the product or service provided by your business.

  • Liabilities – There are two sorts of Liabilities:
    • Current Liabilities – This is anything that needs to be paid within the current financial year, including debts to Creditors, Short Term Loans, and any overdraft on your bank accounts.

    • Long term Liabilities – this covers anything that you owe that you have to pay off in a longer period then 12 months. Normally this includes loans, Hire Purchase, etc.

  • Margin –The difference between the sales and the cost of sales.

  • Net Profit – This is the figure that is left once you have taken any expenses off of the Gross Profit and added any other income.

  • Owners Equity – It is important to note that the owner of the business and the business itself are two separate things. Even if you are the sole owner of the business, you are still not "the business". The Owners Equity is the difference between the Assets and Liabilities, and depending on the circumstance, it can either be owed to the owner, or owed to the business by the owner.

  • Profit – Your profit is a number on a page that encompasses many things, not just the money in your bank account. It can include things like the stock in your premises, fixed Assets, or even materials in the factories awaiting production.

  • Profit and Loss account – This is the name used for the day to day record of the income and expenses of your business during a financial year.

Once you find you are understanding the accounting terminology then you will feel more confident when dealing with the accountant or book-keeper. That being said, most accountants and book-keepers are only too happy to help explain anything that their clients are unsure of.

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