35 Common Bookkeeping Terms You Should Know
Bookkeeping is the process of recording, classifying, and summarising financial transactions.
To get started with bookkeeping, it's important to understand common terms and concepts of accounting. This article will help explain the most basic ones!
Why Understanding the Terminology of Bookkeeping is Important
Understanding bookkeeping terminology is important for business owners, managers and accountants.
The financial statements are made up of a variety of line items that utilise terms you may need to become more familiar with.
Some of these can be confusing or even misleading if they need to be correctly understood.
For example, "depreciation" sounds like something that happens to a car or home—and while it does occur in those settings, its meaning in your business will depend on what kind of asset we're talking about (machinery or equipment vs land) and how long it has been in service (a few years vs decades).
Understanding the terminology associated with bookkeeping will also help you understand your business better as a whole by giving context to key financial metrics such as profitability, cash flow and profitability ratios.
Accountants are highly trained professionals who prepare financial statements.
Accountants follow specific guidelines to correctly record transactions and maintain records for businesses, nonprofits and individuals. Accountants also assist with tax planning, tax preparation and audits.
In addition to academic coursework qualifying them as CPAs (Certified Public Accountants), many accountants earn master's degrees in accounting or other professional fields of study.
While some small businesses may hire bookkeepers without formal education, anyone preparing official financial statements should be properly trained in accounting principles.
2. Accounts payable
Accounts payable are monies owed to creditors. It's important to note that it does not include any debt you owe to a bank for business loans or credit lines.
In other words, accounts payable should only reflect money owed directly from your business and not from banks (such as Visa or American Express).
3. Accounts receivable
Accounts receivable refers to a debt owed by the company to its customers. It is not a liability but rather an asset that appears on the balance sheet.
- Accrual basis accounting is a method of accounting in which income and expenses are accounted for when they are incurred, even though payment may be received or paid later.
- The term accrual refers to revenues earned but not yet collected and expenses incurred but not yet paid — both of which happen on an ongoing basis throughout the year.
5. Accrued expense
An accrued expense is an expense that has been incurred but has yet to be paid.
6. Accountants' report
An accountant's report is a document that summarises the financial transactions of your business and provides additional information, such as how much money was spent by each department.
This document is important to understand because it shows you where your company stands financially, and it can help determine whether you need to adjust your spending habits to stay in the black.
7. Accounting period
The time period for which a business reports its financial results.
The accounting cycle is the process of recording and reporting the financial transactions of a business.
It includes three parts:
- Cash receipts journal, which records all incoming payments
- Cash disbursements journal, which records all outgoing payments
- Ledger, where each transaction is listed with its date and type (purchase or sale).
The money invested in a company by its owners is called shareholders. For example, if you buy stock in Apple, you're investing your capital into the company.
9. Balance sheet
A balance sheet is a snapshot of the company's assets, liabilities, and equity at a point in time.
It provides information about the financial condition of a business entity. Assets are a company's assets, such as cash or property.
Liabilities are debts or financial obligations it owes to others—for instance, loans from banks. Equity represents the owner's investment after accounting for all outstanding liabilities.
10. Cash basis accounting
The cash basis of accounting is used by businesses that sell on credit, such as retailers and wholesalers.
It is also the most widely used method of accounting in small businesses that are optional to maintain formal financial records by law.
The cash basis of accounting does not recognise revenue when it is earned but only when it is received in cash or a check has been cashed.
Similarly, expenses are recognised when they are paid out of cash or checks have been written against an account with adequate funds available to cover them.
11. Cost of goods sold (COGS)
COGS is one of the most important elements of a company's income statement since it represents the amount of money spent to generate revenue.
COGS is calculated using the following formula:
COGS = Inventory at the beginning of the period + Purchases - Inventories at the end of period
For example, if you have $1,000 worth of inventory at the beginning of your accounting period and make $3,000 in purchases during that same time frame (so your total cost for goods sold is $4,000) but then sell all $4,000 worth of inventory before closing out your books at year-end (so your ending inventory is zero), then your COGS would equal $1,000 plus $3k minus 0 = 4k.
12. Cash flow
Cash flow is the amount of cash you have at a given time. It's an important aspect of your business that determines whether or not you will be able to pay your bills on time.
Cash flow is the difference between your income and expenses. If you have more income than expenses, then your cash flow is positive, and you are increasing the amount of money in your bank account.
Conversely, if you have more expenses than income, then your cash flow is negative and decreases the amount of money in your bank account.
Dividends are a portion of a company's earnings that are paid to shareholders.
The dividend can be either paid in cash or stock, depending on the company's financial health and its preference.
Dividends may also be issued out of after-tax profits or can represent a return on reinvested profits from previous years.
Diversification is one of the most important concepts in investment management.
It can be used to reduce risk, increase returns and help ensure that your portfolio stays on track despite market fluctuations.
Diversification helps you spread your investments among different asset classes and industries in order to reduce risk.
Having a mix of stocks, bonds, and cash (or equivalents) can help mitigate losses in case one asset class performs poorly or is affected by an economic downturn.
15. Single-entry bookkeeping
Single-entry bookkeeping is the simplest of all accounting methods. In this system, a transaction is recorded only once in an account.
For example, if you buy supplies for your business and pay $150 for them, then that expense would go directly into one of your accounts (such as "supplies") and be recorded as $150. The double-entry method will be discussed later in this post.
Single-entry bookkeeping has been around since ancient times and was first used by merchants who needed a way to keep track of their inventory and sales transactions.
It was also used by farmers who wanted to know whether they had enough money left over after paying their bills each month so they could decide if it would be worth planting crops next spring."
16. Double-entry bookkeeping
- Double-entry bookkeeping is a system of bookkeeping where every transaction is recorded in at least two places.
- It's the most common form of accounting used by businesses to keep track of their financial transactions.
17. Taxable income or Taxable earnings
Taxable income or Taxable earnings is the amount of income that is subject to tax. In other words, it’s your gross income minus any allowable deductions.
Taxable earnings are also known as taxable income because the government taxes them, and you pay taxes on them.
18. Variable cost
A variable cost is a cost that directly affects the level of activity. This means that if you produce more, you'll pay more for your raw materials and labour, for example.
Examples of variable costs include:
- Labour Costs (direct wages/salaries)
- Utilities (electricity, gas)
Turnover is the total sales of a company, calculated by multiplying the number of times a product or service was sold by its price.
For example, if a company sells 1,000 computers at $500 each, its turnover would be $500,000.
Turnover can also be calculated for each product or service separately.
- The turnover rate is the ratio between sales and capital employed (i.e., cost of goods sold plus wages and salaries paid) in a year. It's expressed as a percentage and shows how efficiently your business uses its money to generate revenue over time. For example: If you have $5 million in sales with $4 million invested in equipment, materials, etc., then your turnover rate would be 80% ($5 million/ $4 million).
- Gross profit margin: This is the difference between revenue (sales) and cost of goods sold minus operating expenses such as direct labour costs plus royalty fees for patents owned by the business—and it's expressed as an absolute percentage regardless of whether these figures were positive or negative during any given period
Profit is the difference between revenue and expenses. It's the bottom line on your income statement, and it represents the amount of money left over after you've paid out all your costs—be they direct costs like raw materials and labour or indirect costs like marketing.
Profit is an important indicator of how well a business has performed throughout the year; if you're looking to start one, make sure that your numbers are showing a positive profit at least once in a while!
This term may seem too basic to include here, but don't be fooled:
knowing exactly what "profit" means can help you better understand other accounting terms.
For example, if someone mentions that they want their company's earnings before taxes (EBIT) to be high enough so they can pay off their debt within five years—that's because debt is one type of expense commonly incurred by businesses (think loans).
21. Profit and loss statement
The profit and loss statement (P&L) is a statement of a business's income and expenses over time.
It can be prepared monthly, quarterly or annually, depending on how often you need to know how your business is performing financially.
P&Ls are used by many businesses to assess their financial performance and make decisions about future investments in assets that will help them grow.
The preparation of this statement may involve manual or electronic bookkeeping processes, depending on what accounting software you're using.
It's important to understand the difference between cash basis versus accrual basis reporting in order to ensure that your accounting practices match those required by law when preparing your P&Ls (see below).
22. Net profit margin
Net profit margin is the ratio of net sales to net income. It is calculated as net sales divided by net income, or net income x 100 / net sales.
As a ratio, it tells you how much profit you made on each dollar of revenue that came through the door.
Higher ratios mean more profits for your business; lower ratios mean less profit and possibly even losses (if the bottom falls out).
23. Return on investment
Return on investment (ROI) is a ratio that measures the effectiveness of an investment.
ROI can be calculated by dividing an investment's earnings by the amount of money invested.
For example, if you made $100 from your invested capital, this would be a 100% return on your investment.
If you made $200 from your invested capital, it would be a 200% return on your investment.
24. Present value
Present value is the sum of all future cash flows, discounted at the rate of interest.
The discount rate reflects an assessment of the riskiness of the cash flow and its timing.
Present value calculations are used to compare different investments with each other or with other uses for funds.
Suppose two investments have similar future costs, but one has a higher present value.
In that case, investing in that investment will be more profitable because you will receive more money than if you had invested in another option with a lower present value.
Which would you choose if you were offered $100 today or $100 tomorrow? We'll assume that both options are equally likely; there's no reason to think that one might come sooner than another.
The second scenario offers us a choice between receiving $100 either now or in one year from now.
This means we have time on our side: if we hold onto the money for a year and invest it at 5% interest per year ($5), then we'll have $105 next year when it comes time to pay up.
25. Materiality principle
The materiality principle is how accountants determine what information to include in financial statements.
This principle states that all significant transactions are to be recorded and disclosed unless they are immaterial.
The term "materiality" often refers to the amount of money involved in a transaction or event, but it's more than just an amount; it's also about the significance of an item in relation to the business.
For example, while $100 may not seem like much money on its own (especially if you're used to dealing with multi-million dollar transactions), it could have a big impact on your bottom line if you're only expecting a small profit from one transaction and that $100 makes up 20% of your expected profit for that one sale.
In short: materiality is a subjective judgment made by accountants and management about whether something should be included in financial statements for reference purposes or not.
Liquidity is a term used to describe the ability of a business to pay its bills. This means that the amount of cash on hand or in the bank, plus any accounts receivable (money owed to you), is enough money to cover all expenses, including payroll and other short-term obligations.
In order for an organisation's financial situation to be considered liquid, it must first have enough cash on hand at any given time so that all current liabilities can be paid off immediately if they were due immediately.
If this condition holds true, any remaining assets can be sold off quickly. For example, say you own an accounting firm with $200K in debt ($100K on credit cards, $50K on loans from family members). If these debts were due today—and had no grace period or interest attached—you would have enough liquid assets available to pay them off without having trouble meeting your other obligations, such as paying employees' salaries or rent/utilities.
27. High-low method
The high-low method is a single-entry accounting method that uses the average of the high and the low to determine the cost of goods sold.
It's typically used to account for inventory but can also be applied across other types of assets.
The formula for calculating COGS using this method is:
COGS = ([Month 1 Average Cost] + [Month 2 Average Cost]) / 2
The term insolvency refers to the state of not being able to repay one's debts. The law recognises two types of insolvency:
- Insolvent liquidation - The process by which an insolvent company is run down and wound up under court supervision in order to pay its creditors as much as possible; and
- Insolvent administration - A form of corporate rescue that enables a company with assets but insufficient working capital or profitability to continue trading whilst attempts are made to seek additional funding from investors or lenders.
Insolvency occurs when the total amount owed by a person or other entity (e.g., corporation) exceeds the total assets they own at that time (e.g., debt).
An invoice is a statement of charges made for goods or services rendered. The seller may issue it to the buyer or by an agent to his principal. An invoice is also called a bill of exchange.
An audit is a process of reviewing financial records to determine whether they're valid and reliable.
The auditor performs this service by comparing an organisation's financial statements with its physical assets, payroll records, and other documents to ensure everything adds up.
The auditor also checks for internal controls that reduce the likelihood of errors, fraud or misuse of assets.
Audits are typically performed by independent accounting firms or public accounting firms that specialise in auditing through legal certification requirements.
31. Chart of Accounts
A chart of accounts is a list of all the accounts in your accounting system. It is used to organise financial information by type and/or category (i.e., Assets, Liabilities, Equity).
Collections are a bookkeeping term that refers to money you receive from customers.
Collections can come in the form of cash or credit card sales. This money is recorded in your general ledger as part of collections, even if it isn't actually deposited into your bank account.
33. Expense Report/Cash Expense Report
A cash expense report is a report that shows the cash expenses for a period.
it may also be called a cash flow statement because it shows how much money has been spent on business operations.
In other words, this document shows what you have paid over time to continue running your business.
The key purpose of this report is to inform managers and owners about how much money they are spending each day or week so that they can better control their finances and be able to make changes if necessary.
34. Fixed Assets/Fixed Asset Schedule
A fixed asset is a piece of equipment that becomes a part of the company's property, usually for five years or more.
A fixed asset schedule lists all of the company's fixed assets and their values, including depreciation schedules.
35. General Ledger
The general ledger is the master file of accounts. It contains the accounts that you use to record transactions.
The general ledger is also called the nominal ledger because it lists all of your organisation's assets and liabilities in one place.
The general ledger is usually divided into two parts: assets and liabilities, with each section containing subcategories such as cash, inventory, etc.
Bookkeeping is the art of recording and analysing financial transactions. It's a vital part of any business because you wouldn't know how much money was coming in or going out without it.
Bookkeepers are also responsible for ensuring that your company files its taxes correctly using proper accounting methods such as single-entry and double-entry bookkeeping methods.
Many different types of accounts are used by businesses today, but they all fall under one umbrella called a Chart of Accounts or COA, which includes income accounts (revenue) and expense accounts (costs).
These two types balance each other out, so there is always zero net change at the end of each accounting period!
FAQ's Related to Common Bookkeeping Terms
1. What is the golden rule in bookkeeping?
The golden rule in bookkeeping is that every transaction must be recorded. The first step to recording a transaction is deciding whether it will be recorded in the journal, ledger, or accounts. Transactions can be recorded as a credit or debit entry, an increase or decrease to an account balance, and sometimes both!
2. What is the need to tally the Balance Sheet?
Tallying the Balance Sheet is a vital step in preparing any financial statement. The accountant tallies the balance sheet to ensure that the numbers are accurate so that they can prepare their financial statements and tax returns.
The accountant may also tally the Balance Sheet to prepare a cash flow statement.
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