As a leading provider of accounting services in Niagara, we see a lot of small business owners who do incredible work and have profitable returns but may not have been exposed to all the terminology needed to read and understand a financial document.
That is because so many small business owners have incredible motivation and come from a wide range of backgrounds that often does not include an accounting degree. However, these critical innovators make up most of the business happening around Canada.
That is why many of our clients search for a “CPA near me” on Google to find helpful guidance and a team that can manage their taxes and financial documentation, like us at HQ Accounting.
Accounting terms can seem overwhelming and intimidating at first, but once you get the hang of them, they will become second nature. The process of accounting involves a lot more than just adding up numbers. You need to know how to interpret those numbers as well as what they mean for your business.
This article will help break down some standard accounting terms so you can better understand how they’re used within your company’s finances.
Commonly Used Accounting Terms
1 – Balance Sheet
A balance sheet summarizes a company’s financial position at a given point in time. It shows the assets, liabilities, and equity of an entity. This is the big-picture view of your business and how its financial health is progressing over time.
The three main components of this statement are:
- Assets – These are what you own, such as cash or property.
- Liabilities – Your obligations to other entities, such as taxes.
- Equity – Equity is the difference between your assets and liabilities (the net worth).
2 – Income Sheet
The income statement is a measurement of your business’s profitability. To calculate it, add up all the revenue you bring in and subtract all the expenses you incur.
Put simply, if your business has $100,000 in sales and $25,000 in expenses, your profitability will equal $75,000 ($100,000-$25,000=$75,000).
This number is critical because it determines your tax obligation at the end of the year or quarter. The more profitable you are, the larger your taxes. You can use expenses and other deductions to lower your profitability, so your tax bill is less impactful, and you have more to invest in your company’s future. Our quality team of bookkeeping services in Niagara can help you do this efficiently.
3 – Cash Flow Statement
A cash flow statement is a financial report showing a business’s cash inflows and outflows. It’s like an income statement, but it covers just one period — usually a month or quarter — instead of the entire year.
The cash flow statement is prepared after the balance sheet and income statement. This allows you to see how much money actually came in (and went out) during that period.
Tracking the flow of your cash assets is used by bookkeepers, CPAs, and tax professionals to ensure all your reporting is accurate.
4 – Gross & Net Income
Gross income is the total amount of money that comes in. Net income, however, is the amount left after all expenses have been deducted.
Like our example above, this is the profitability of your business. This is a great way to determine who you should partner with as a small business. If they always talk about their $2 million dollar business earnings but never let you in on the actual net income, they could be hiding how much it costs to operate (expenses) their company.
5 – Retained Earnings
Retained earnings are a company’s net profits over the years. They generally include retained losses, as well. Retained earnings are used to grow the business, pay dividends and buy back stock.
So, if you have a net income of $25,000 every year for 5 years, you will have retained earnings of $125,000 recorded on your taxes ($25,000 x 5 years = $125,000). Most of the time, you will spend money paying employees or buying new assets out of your retrained earnings.
6 – Expenses Vs. Debt
It’s important to differentiate between expenses and debt because they have two different purposes. You can leverage debt, but it is hard to get around paying your costs regularly.
An expense is a cost you must pay to run your business. This includes all the things you need to buy and pay for monthly and annually, like rent, salaries, and supplies, as well as miscellaneous expenses like maintenance costs or legal fees. Expenses are usually short-term, meaning they come up while running your business but don’t last forever once paid off.
Debt is money you borrow from someone else, like a bank or other lender. It’s generally considered long-term because it can take months—or even years—to pay off, depending on how much debt you owe and how fast interest accumulates each month on top of what you’ve already paid back.
7 – Types of Assets
Assets are property or valuable equipment/resources your company owns. Any quality accounting services near Niagara will want to know the value of your assets because it speaks to the overall value of your business in case you want to eventually sell.
Your business may have several different assets, but there are seven common categories:
- Cash/Cash equivalents (money in the bank)
- Accounts receivable (money owed to you by customers)
- Inventory (items you keep on hand for sale or use in production or delivery)
- Land and buildings (real estate used for commercial purposes)
- Equipment (machinery, tools used to create products or deliver services)
- Intangible assets (things that cost money but aren’t physical—patents, trademarks, etc.)
8 – Invoicing & Accounts Receivable
Knowing when and where money is coming in is critical to successful business operations. Generally, this is gained by collecting invoices and previously owed payments from customers.
An invoice is a document showing the goods or services you have provided to a customer. The invoice is sent to your customers after they have paid for their purchase, as per the terms of payment agreed upon in your business contract with them.
Accounts receivable, also known as AR, refers to the money customers owe you for products delivered or services rendered. Think of this like a bar tab for a customer who needs to pay for their drinks at the end of the night, just on a bigger scale.
9 – Burn Rate
The burn rate is the cash a business needs to run each month. It’s calculated by dividing the monthly cash burn by the number of months of remaining cash, and it can be used to assess the viability of a business.
For example, if someone invested $200,000 into your new startup coffee shop and it costs you $20,000 in expenses each month, then you have 10 months of operations before you need to start earning profits ($200,000 / $20,000 = 10 months).
The burn rate is essentially judging how long you can be in business before your operations turn a viable profit.
10 – Depreciation
Depreciation is a method of recovering the cost of an asset over its useful life. There are two types of depreciation – straight-line and accelerated. The two differ in how quickly the asset’s value is depreciated over time.
This is hands down one of the most confusing parts of accounting that often gets mixed up with expenses and asset valuation. Speak with a CPA near me or bookkeeping services in Niagara to give your small business a better idea of how to document this term.
11 – Cost of Goods Sold
Cost of goods sold (COGS) refers to the cost of producing or procuring the products you have sold. This is important because it affects your gross profit and net profit calculations.
Essentially you are trying to measure how much money it takes to create or receive a product to sell.
If you own an olive oil business, all of the equipment and natural resources used to grow, cultivate, harvest, and ship that product are considered COGS.
If you have a resale retail shop, the cost to acquire all of the products you sell, like delivery, shipping, packaging, etc., is part of your COGS. Again, quality accounting services in Niagara, like our team at HQ Accounting, can help you determine this valuation.
12 – Break-Even Analysis
Break-even analysis is a way to determine the number of units you need to sell to cover your costs. This is probably the most important number for you to know as a small business owner. It will determine how much money you need to earn every period to not be in further debt.
Once you surpass your break-even point, you are earning money in your business and can grow.
Understanding Accounting Terms is Essential for Your Small Business
Accounting terms are used in bookkeeping, financial statements, and tax returns. Accountants and bookkeepers use accounting terms to track a company’s finances, evaluate its health, and provide interested investors with insight into how viable that business may be in the future.
You should also be able to understand these terms if you plan on starting your own business or working with an accountant at some point in the future.
If you have questions about these accounting terms or want to start your own business, but feel a little bit out of your wheelhouse, give our HQ Accounting professional team a call.
We offer premium accounting services in Niagara that can help you navigate the complicated taxes and record keeping involved in running a business. Let our experts give you the support and answers you need to ensure your future success! Book your 15-minute discovery call today!