financial terms

Financial Terms Glossary

The finance and accounting world utilizes terms to quickly refer to a process or procedure. These terms can be intimidating for the entrepreneur and small business owner.  Terms that can make the controller or CFO come off as too technical. The following financial terms glossary is written for non-accountants and avoids much of the technical terminology you will find in textbooks and the internet. This is written in real world language. 

A

Accounts payable – Represents the expenses incurred (i.e. you purchased product or service) but have not paid for yet.

Accounts receivable – The amount of money that is owed to you for providing a product or service to a customer. These are funds that will be received in the future.

Accrual basis of accounting – The recording of all items that are owed to you or that you owe, regardless of whether you have paid for them or received the cash. Some accrual entries are based off calculations. The best what to think of it, is if you stopped doing business today, what would you owe and what would be due to you to settle all debts and collect all receivables.

Accrued expenses – Typically represent payroll and interest on debt. An example is if your employees work Saturday through Friday and get paid the following Wednesday, as of Friday you owe the employees for time worked, regardless of when you pay them. You only want to record accrued expenses for payroll at the end of the year.

Accumulated depreciation – As the name indicates, this is where you accumulate the depreciation expense you have incurred over the life of an asset. See Depreciation expense for description on depreciation.

Amortization expense – In the accounting world, any asset that does not have an infinite life and is not considered a fixed asset has its cost ‘amortized’ versus ‘depreciated’. This is more of a semantics, as both represent non-cash expenses that affect the net income

Additional Paid In Capital (APIC). This represents the amount of money someone pays to own stock in your company above and beyond the par value of the common stock. So, if the par value of your common stock is $1 per share, and someone pays you $5 per share, the difference between the $1 par and $5 purchase represent the additional paid in capital.

B

Balance sheet – The balance sheet represents the summary of your total assets, liabilities, and equity in your company. The simple formula for the balance sheet is; Assets = Liabilities + Owners Equity. As the name implies, the balance sheet should balance.

Bank reconciliation – One of the most critical control elements of your company is the bank reconciliation. In simplistic terms, the bank reconciliation reconciles the balance per your cash account on your general ledger to the balance per your bank statement.

C

Cash basis of accounting – When using the cash basis of accounting, you only record the income when you receive actual cash and only record an expense when you actually pay an expense. The danger of using this basis of accounting is that you cannot properly analyze your company or forecast your next couple of years.

Cost of Goods Sold/Cost of Sales – The Cost of Goods Sold (COGS) or Cost of Sales (COS) represents the total amount of costs it took to produce your product. The common items in COGS are direct material, direct labor and overhead. If you sell a product, it is absolutely CRITICAL that you have an accurate COGS. Without an accurate number/calculation, you will never be able to make money.

Credit  – In the accounting terms, a ‘credit’ represents ½ of an accounting entry. Categories that predominately have credit balances, sometimes shown as negative or with brackets, are Liabilities, Equity, and Revenue.

Current assets – Current assets represent assets that can either be converted to cash or used within one year. It is important to understand what your current assets are as the total of all your current assets plays a key role in many financial statement ratios. It’s also a key factor banks look at during financing loans.

Current liabilities – Current liabilities represent liabilities that will be paid or cured within one year. It is important to understand what your current liabilities are as the total of your current liabilities plays a key role in many financial statement ratios. It’s also a key factor banks look at during financing loans.

Current portion of long-term debt – This represents the total payments you will have to pay on any long-term debt for the current year. Think of this as your note payments you must make over the next 12 months.

D

Debit – In the accounting terms, the ‘debit’ represents ½ of an accounting entry. Categories that predominately have a debit balance are: Assets and Expenses.

Depreciation – This is how you recognize costs on your income statement related to a fixed asset purchased. A method of allocating costs that have been capitalized in a systematic fashion over the life of the asset.

Distributions/Dividends – This represents the way you can take profits out of a company without affecting the income statement. Distributions/dividends are considered a reduction of capital accounts and are not an expense of the company.

Double entry bookkeeping – This is what all accounting is based on. For all debits in a journal entry, there should be enough credits to offset the entry and make the entry balance.

E

EBIDTA – Earnings Before Interest Depreciation Tax and Amortization (EBIDTA). The formula is what most banks used to determine the profitability of a company from a cash standpoint. Understanding this calculation in your financials is critical when going for a bank loan or proposing to investors.

Equity – This represents the funds in your business after all liabilities are paid off. This is how you build up wealth in a company.

F

Financial ratios – Financial ratios are a quick mechanism to be able to take significant amounts of data and analyze them quickly and effectively. There are hundreds of financial ratios you can use when analyzing your financial statements.

Fixed assets (Property, Plant & Equipment) – Fixed assets represent all your computers, furniture, equipment, buildings, etc.

Footnotes – Footnotes represent a narrative to the financial statements of significant items that have occurred in the presented financial statements. The footnotes will be in the same order as the balance sheet and income statement.

G

GAAP – Generally Accepted Accounting Principles (GAAP). These govern the accounting ‘rules.’

General and administrative expenses – These are category classifications on the income statement. Any expense that is not necessary to assemble the products is usually classified into general and administrative.

General journal entries – General journal entries are how you will record a transaction that does fit into cash receipts (sales invoices) or cash disbursements (expense invoices).

General Ledger (GL) – The general ledger is all the respective data in your accounting records. The general ledger will show each account beginning balance, activity for the period or year, and ending balance.

I

Income Statement/Profit and Loss/Statement of Operations – The income statement, also known as the Profit and Loss or Statement of Operations, is where you will show all income you have earned for the period and all expenses incurred for the period.

Intangible assets – Intangible assets represent costs that have been capitalized but do not fit into the fixed asset category. Typical intangible assets are organization costs, patents, and goodwill.

Interest expense – Interest expense represents the cost of borrowing money. Interest is usually recorded at the time of a note payment.

Investments – Investments are funds invested into CDs, Mutual Funds, Bonds, and other instruments.

L

Line of credit – A line of credit is the ability to draw on funds from a bank. It is like a credit card, but with immediate access to cash.

Loans to shareholders/owners – Commonly in a start-up company the shareholders or owners will loan funds back to the business for various reasons. The loans to shareholders or owners are a liability to the company.

Long term debt – This represents the liabilities on your books that are to be paid back over a time frame greater than one year. This typically is in the form of a mortgage or note payable.

N

Notes receivable – Notes receivable represent the money due to the company over a term greater than one year. Notes receivable represent a loan the company has made to an individual or organization.

O

Operating expenses – Operating expenses represent the expenses needed for day to day operation. It is important to separate your operating expenses out.  This number is important when calculating operations ratios.

Owners contribution/capital – This represents the funds an owner has invested into the company. Typically, the owner’s contribution will be Cash, however contributions can also take the form of assets contributed, such as equipment.

P

Prepaid – This represents expense that have been paid for, but not yet incurred. Typically, prepaids come in the form of insurance, such as paying for a full year of insurance ahead of time. Prepaids are taken to expense on a straight-line basis over the life of the policy.

R

Revenue – This is what you have earned on selling a product or service. The key here is what you have earned, regardless of when cash has been received.

S

Stock – For corporations, the way to gain ownership in the company is to purchase stock. Stock certificates will either have a stated par value, such as $1 per share, or no value, such as no-par value. This helps to determine how much should be booked as a stock on the balance sheet and how much should be booked as Additional Paid In Capital (APIC).

T

Tied out – This is a term accountants use when they are verifying the accuracy of an account. The accuracy is not performed by printing out the general ledger detail, but from reconciling the account balance to another account or outside information.

Trial balance – The trial balance is a listing of all the accounts in your accounting system, including account balances. The sum of all the accounts should equal zero or all debits balances should equal all credit balances.