Accounting Terminology Basics

Though, of course, as a business owner you will need to relay upon the skills of a qualified accountant to help with the financial management and reporting of your business, it is important that you develop a keen grasp of some of the concepts and principles involved in managing the finances of your business.

Here are just a few key terms that are useful to know.

Assets

Both tangible (Physical) and intangible (non-physical) these essentially represent everything your business owns and include items such as vehicles, computer equipment, buildings, plant, machinery, cash, copyrights, trademarks and patents.

Capital

This is effectively the money you invest to start and grow your business. Commonly referred to as ‘working capital’ this refers to funds that can be readily accessed and does not include assets and liabilities of the business.

Cash Flow Forecast

In any business ‘cash is king’, it’s the lifeblood of the business and you must ensure that you always have enough of it to sustain and grow. Therefore, a cashflow forecast is one of the most vital tools required to run your business effectively. It effectively measures all of the cash inflows and outflows of your operation into the future thus acting as a key aid to the decisions you make in terms of where you spend your money.

Burn Rate

Following on from the concept of cash flow your burn rate effectively tells you how quickly your business spends money, and is an important measure in determining the sustainability of your business is and how viable it will remain a certain level of operation. To calculate your burn rate over, for example, the course of the year, you simply need to subtract your cash on hand at the end of the year from what was available at the start of the year and then divide by the number of months in the period.

Cost of Goods Sold (COGS)

This represent the costs involved in delivering your product or service and is a vital component in calculating your company’s gross margin. In terms of managing your profitability this is a key element as by reducing your cost of goods sold you can actually increase your profitability without achieving any additional sales.

Accounts receivable and payable.

Quite simply accounts receivable represents money you are owed into your business and those payable are what you owe out of the business. The former is treated as an asset on your balance sheet whilst the latter is deemed a liability.

Depreciation

This reflects the decrease in value of your company assets over a period of time. This is an important concept when working out your tax calculating and is a key area in which your accountant will be able to assist.

Equity

This refers to the amount invested in the business by its owners and can be defined as the difference between your liabilities and what you actually own. A business that has a healthy equity position is typically more attractive to potential buyers, lenders or investors.

EBITDA

Standing for earnings before interest, taxes depreciation and amortisation, this measure is most often used as a clearer, rawer measure of a business’ underlying profitability.

As it removes the impacts of non-operating elements such as interest, taxes and depreciation it provides a truer measure of a businesses operating profitability. This is why it’s used as the primary measure in assessing the performance of businesses within sectors and used by investors when deciding if and how much to invest in a business as well as using it to assess the true underlying value of the business.