11 Basic Accounting Terms Every Small Business Owner Must Know

While most small business owners are not accounting experts, it’s hard to argue against the importance of having a basic knowledge of accounting terms or concepts. Not only does having a basic understanding of accounting help people evaluate the financial performance of a business, it can also help avoid potential accounting errors or instances of non-compliance. In this article, we look to explain the 11 most basic accounting terms we feel all business owners should know.

1. Accounts Receivable and Accounts Payable

Accounts receivable is the amount of money customers owe for acquiring a company’s goods / services. This sum can be found on a company’s balance sheet and as customers are legally obligated to pay this outstanding amount, it is recorded as a creditable asset.

Accounts payable reflects the amount of money a company owes to others, but has not yet settled. Accounts payable is also found on a company’s balance sheet and is recognised as a liability. This is because the company has yet to settle their outstanding payment obligation.

It is important to understand the differences between accounts receivable and accounts payable as they both provide insight into a company’s cash flow situation and their financial health. If a company does not keep track of these accounts, it can result in outstanding invoices and overdue payments which can pose a serious impact on a company’s financial situation.

2. Balance Sheet

Balance sheets is a type of financial statement that states a company’s assets, liabilities and equity for a specific financial year. Balance sheets are used to understand exactly what a company owns, its liabilities to other parties, and the amount of money that has been invested by its shareholders.

Companies that are looking to acquire a loan or are seeking means of funding will often have their balance sheet analyzed by interested parties. This is because analyzing a balance sheet can provide others with a more comprehensive understanding of a company’s financial health. Most importantly, business owners must realize that a balance sheet has to be balanced at all times!

3. Bank Reconciliation

Bank reconciliations is the process of making sure that a company’s general ledger accounts match up with the company’s ending bank balance for a specific financial period.

Because the bank reconciliation process helps ensure accuracy and a fair representation of a company’s bank transactions, this process should at least be completed on a monthly basis.

To minimize any potential errors when it comes to performing bank reconciliations, it is recommended to engage a certified Hong Kong CPA firm to help perform your bank reconciliations and to advise on any compliance related matters as they arise.

4. Cost of Goods Sold (“COGS”)

COGS is the term used to categorize all direct costs incurred by a company to produce their goods / services. Such costs include the cost of materials and labor directly associated with creating the goods / services.

Small business owners must understand what their COGS is. Doing so will help business owners better understand their profit margins as COGs are direct expenses that affect a business’ bottom line. In addition, frequent review of a company’s COGs can present opportunities to identify new ways to improve a company’s profitability.

5. Depreciation

Depreciation refers to an asset’s loss of value over a period of time. However, assets must have considerable value in order to warrant depreciation. Examples of such assets include plants, property or equipment.

Business owners can look at their company’s income statement to find depreciation, as it will be recorded as an expense. In addition, contrary to popular belief, depreciation does not have a direct impact on a company’s cash position.

Having an understanding of what assets can be depreciated, and how they are calculated can help business owners not only plan for the use of their assets over a multiple accounting periods, but can also help accountants prepare the company's profits tax computations

6. Financial Liabilities

In accounting, financial liabilities are recognised as the sacrifice of any future economic benefit as a result of past transactions / events. Such liabilities can be categorized as short-term (expected to be settled in 12 months or less), or long-term (expected to be settled after 12 months or more).

Business owners should understand what financial liabilities are as this term is often confused with expenses. While expenses can relate to a company’s operational cost and are recorded on a company’s income statement, financial liabilities are recorded on a balance sheet.

7. Financial Year

For companies to prepare their financial statements, they must close their company accounts annually for year end reporting. A financial year-end date signifies the end of a company’s 12 month accounting period and will help companies in the process of preparing their annual financial statements.

Business owners need to dedicate time to deciding the financial year-end of their company as this date will determine the company’s annual timeline for preparing their audited financial statements and the submission of their profits tax returns.

8. General Ledger

Companies will have a complete record of all their accounting transactions in a general ledger. General ledgers represent all the financial transactions made by a company in a given financial year.

As accountants and auditors will frequently rely on general ledgers for their work, businesses should make sure to always maintain up-to-date general ledgers as part of their bookkeeping routine.

9. Management Accounts

Management accounts are a company’s internal financial statements. These documents contain information ranging from a company’s profit and loss accounts, cash flow statements and balance sheets.

Typically, companies will prepare their management accounts on a monthly or quarterly basis as utilizing the information stated in these accounts can help business owners make short-term business decisions.

10. Trial Balance

Companies use bookkeeping worksheets to confirm their account figures before producing formal financial statements. These worksheets are known as trial balances.

Trial balances are prepared periodically to help make sure that the bookkeeping entries of a company are correct. Trial balances will also list all the bookkeeping ledgers of a company, and compile this information into equal debit and credit amounts.

Because auditors will often request trial balances when conducting an audit, as they are the starting point for validating a company’s financial statements, it is important for business owners to properly update trial balances on a frequent basis.

11. Working Capital

The necessary expenses a company incurs for their business operations is known as working capital. Working capital is also recognised as the difference between a company’s current assets and its current liabilities. Business owners should understand what working capital entails as doing so can help them evaluate their company’s run rate and their capital requirements.