Accounting Terms You Should Be Familiar With – Part 2
Following on from Part 1 (click here to view) here are more accounting terms that you should be familiar with to enable you to understand your accounts and run your business efficiently.
15 – Debit
Like Credit, the effect of a Debit on the balance sheet is determined by the financial transaction. Debit can increase the assets or decrease the liabilities of the organization.
The opposite of a credit, a debit is an accounting entry made on the left side of an account in double entry bookkeeping. Debits either increase expense or asset accounts or they decrease equity or liability accounts.
16 – Depreciation
Depreciation is an accounting method which determines the amount by which the value of an asset over its assumed lifetime. Depreciation can make money for a business by deducting the appropriate amount from the value of the item for each year of its life for accounting and tax purposes. Some assets have to be depreciated over a period set by the Tax Authorities. It is not unusual for an asset to still be in use when it has zero value on the books.
17 – Diversification
Diversification is a process which calls for capital to be invested into alternative investments which are not related to the core activities of the business. Diversification is a risk management strategy that allows for risk to be spread and to protect the business if the core business fails. Whilst they can lead to better long-term financial growth, it can cause slower short-term growth.
18 – Dividends
Company profits which are paid to shareholders are known as Dividends and are the benefit investors receive for lending money to the business. Dividends can be in the form of cash or additional shares in the business. Dividends can be paid on a regular basis or as special one-off payments.
19 – Double-Entry Bookkeeping
The Double-Entry system is a form of bookkeeping that requires every entry to have an opposite corresponding entry in a different account, keeping the accounting equation in balance – “Assets = Liabilities + Equity”.
Every transaction will have an effect on two accounts be they liability, asset, revenue, equity or expense accounts. Debits and Credits are the two types of entry, debits are entered on the right, credits on the left.
20 – Expenses
Expenses are the costs of running a business and fall broadly into four types – fixed, variable, accrued and operational.
Fixed expenses include items such as rent, salaries, insurance and rarely change month on month. Variable expenses include necessary but often discretionary or unpredictable expenses. Accrued expenses are those which are put through the accounts when they are incurred, not necessarily when they are paid. Operational expenses such as marketing and the costs of operating the business form the rest.
21 – Equity
Equity, whether it be owners or stockholders, is what is left over after a business pays all its debts and sells all its assets. Equity can be tangible and intangible. Tangible assets are things such as buildings, equipment and cash. Intangible assets are things such as copyrights, goodwill, patents, brand) Intangible assets exist as a record on the Balance Sheet
22 – Fixed Expenses
Regular, in both payment and amount, expenses are known as fixed expenses – rent, utilities, salaries. They do not change from month to month and feature in cash flow planning.
23 – General Ledger
General Ledger is an important and often misunderstood term. The General Ledger is the complete record of all the financial transactions that have ever taken place in an organization. Everything, large or small, is recorded.
The information in the General Ledger is used to prepare financial reports and as an aid to understanding financial performance and company health over time.
24 – Gross Profit
Gross profit is the amount left after all the costs of supplying the product or service have been deducted. It is calculated by subtracting the cost of sales from income. Variable, but not fixed, costs are considered. It is an indicator of a company’s effectiveness in producing goods or supplying services.
25 – Gross Margin
The gross margin is what is left over from income after the costs of production and/or supply have been subtracted. Gross margin is indicative of the health of the business. High gross margins means more profit, a low gross margin means costs need to be looked at. In a nutshell Gross Margin = Net Sales – Cost of Goods/Services
26 – Income Statement
Income Statements, more commonly known as profit and loss statements, provide business information covering a specific period of time. In conjunction with Balance Sheets they provide important insights into the financial health of the business.
27 – Inventory
The raw materials used for making products are known as Inventory and appear on the Balance Sheet as an asset. It also includes finished, but unsold, products and work in progress as well as raw materials.
28 – Journal Entry
Business transactions recorded in the General ledger are known as Journal entries. They should include date, reference, account name/number and whether debit or credit as a minimum. Further information may be included if desired.
29 – Liabilities
A liability is something owed by the business and may be for raw materials, payroll, general running costs etc which are regarded as short term liabilities, generally payable within a year. Long term liabilities are loans, mortgages, leases etc and are generally payable over a period of years