25 Basic Accounting Terms You Should Know In 2024

Understanding the ins and outs of accounting terminology

Accounting is often described as the language of business, and the key to understanding this language is the ability to use the correct terminology.

Your financial statements are made up of financial transactions that are recorded in a specific way using accounting principles and based on double-entry bookkeeping.

Using the correct accounting process and basic accounting terms, your bookkeeper and accountant enter transactions in your financial records to create a trial balance.

25 Basic Accounting Terms You Should Know In 2024

Accounting software is used to record each accounting transaction that follows basic accounting concepts to ensure an accurate financial picture of the business.

When following generally accepted accounting practices, your accountant creates a set of management accounts or financial statements for the financial year.

By getting to grips with the accounting cycle and each accounting entry, you, as the business owner or investor, can understand the company’s financial position.

To help you manage your business and understand what your accountant is talking about, here’s a list of basic accounting terms:

25. Equities

Equity is the residual interest in the assets of a corporation after deducting liabilities and is referred to as owner’s equity or stockholder’s equity.

Shareholder’s equity is a measure of the net worth of a company and includes retained earnings used to pay dividends or pay off debt.

To help you master the fundamentals of business, it pays to understand basic accounting principles that you can apply to your company.

24. Double-Entry Bookkeeping

Double-entry bookkeeping started in the late 1400s and is a system that records each financial transaction with equal and opposite entries.

Debits and credits maintain the accounting equation which ensures that both sides of the trial balance total to the exact same value.

Whether it's accounts receivable or accounts payable, your electronic accounting system will ensure that each entry is recorded correctly so that debits and credit balance.

When you file your taxes this year, you will be able to more easily fill in your tax forms after studying these basic accounting terms.

23. Variable Costs

Variable costs change in proportion to how many goods a company produces or sells during the year, as opposed to indirect costs which don’t change.

As production rises and falls, costs such as labor, raw materials, and utilities increase in response to higher or lower sales demand.

22. Fixed Costs

A fixed cost is one of those expenses that is unaffected by increasing or decreasing goods or services sold during the year.

These costs are not directly related to the cost of producing products or services and include expenses like rent, insurance, property taxes, or depreciation.

21. Depreciation

Each asset in your company has a useful lifespan and the accounting system allocates depreciation as a percentage of the cost over its useful life.

This is a useful financial tip, as it can save you a considerable amount of money, especially if you are a small business.

However, the IRS has certain rules regarding how depreciation may be used to reduce tax, such as immediate tax deductions under Section 179.

You may claim a deduction on your tax return using IRS Form 4562, which allows for the depreciation or amortization of tangible or intangible property.

Various assets qualify, such as tangible items like machinery, equipment, and buildings or intangible items like patents or other intellectual property.

To help maximize your return on investment, it pays to follow these small business accounting tips which will help to reduce your taxable income. 

20. Debit

A debit entry increases assets and decreases liabilities or equity, and, from your company’s perspective, it increases the amount of money owed to you.

When you sell to your customers and extend credit, they become liable to you for the sales value and are referred to as your debtors.

19. Credit

A credit entry in your books of account increases liabilities or equity and decreases assets as part of the double entry system of bookkeeping.

From the perspective of your company, a credit increases the amount of money you owe, which is why your suppliers are referred to as creditors.

18. Certified Public Accountant (CPA)

A certified public accountant (CPA) is a professional accountant who has passed the CPA exam and met specific licensing requirements.

Certified public accountants follow the rules laid down by the Financial Accounting Standards Board for companies in the USA, codified as GAAP.

It is important that you appoint a qualified CPA who has experience with accounting for startups, as they can save you a lot of money.

17. Cost of Goods Sold (COGS)

To ascertain your gross profit, you need to calculate the direct costs associated with producing goods or services sold by your company.

Your cost of goods sold (COGS) includes the cost of the materials and the labor directly associated with creating the goods.

To get an accurate estimate of your COGS, you must also have a stock control system that records the opening and closing stock values.

16. Chart of Accounts (COA)

When recording financial transactions, you need a list of all accounts used by a business that is organized and grouped for financial reporting purposes.

The chart of accounts (COA) is usually organized so that the general ledger accounts are grouped logically together, making it easier to create financial statements.

When creating a journal entry, your bookkeeper will select the correct account from the COA or create an account for a particular transaction.

15. Cash Flow Statement

For small businesses, this is the most important financial statement as it reflects its liquidity as money moves in and out of the company.

The cash flow statement reveals all cash inflows from operations and investments and all cash outflows from business activities and investments.

To get an accurate picture of how a company is being run, you need to view the income statement and the cash flow statement together.

The income statement does not reveal your businesses’ cash position and companies that don’t properly manage cash flow do not survive.

Income statements may show that your company is profitable, but if cash flow is poor, you’ll not have sufficient money to pay your debts.

14. Cash-Basis Accounting

Cash-basis accounting is a method that records revenue and expenses only when cash is exchanged, in contrast to accrual-based accounting.

Small businesses and sole proprietorships often use cash-based accounting for its simplicity and since January 2018, The Tax Cuts and Jobs Act has applied.

If a small business taxpayer has average annual gross receipts of $25 million or less in the previous three years, they can use this method.

13. Bank Reconciliation

A bank reconciliation is conducted on each bank account using the cashbook and the bank statement to ensure that the two are identical.

Any differences are noted and corrected and should there still be a difference, then a reconciling item is included to show the reason why.

12. Book Value

Your company’s book value is deduced from its financial statements and is the theoretical value that you’d receive if the business was liquidated.

After selling all the assets and paying off all the obligations and debts, the stockholders are left with an amount of money equivalent to its book value.

This is not what will actually happen, as the company will sell at market value, which may be more or less than its book value.

11. Balance Sheet

A balance sheet is a financial statement that gives you a snapshot of your business's financial position on a specific date.

It consists of current assets, fixed assets, current liabilities, and equity accounts that allow you to see how well your business is doing.

10. Bad Debt

Money that is owed to you by your customers that is unlikely to be collected and results in a loss is considered bad debt.

The IRS allows businesses to deduct bad debt as an expense, reducing their taxable income, so long as the original sale is recorded as income.

9. Assets

Assets refer to the resources owned or controlled by a business, such as cash, equipment, inventory, and money owed to you by your debtors.

Your company’s assets are usually controlled by employing a schedule that records the date received, its value, and any depreciation allowed.

8. Allocation

Financial statements are only as useful as the quality of the allocation to the correct accounts within your accounting system.

To extract accurate information and correctly calculate profits and taxes, the distribution of costs or resources among departments or projects must be correct.

When making a decision to install Xero vs Quickbooks, it helps to understand the ease of allocating transactions with their online versions.

7. Accrual-Basis Accounting

Most businesses use the accrual accounting method to record revenue and expenses at the time that they are earned or incurred.

Regardless of when cash is exchanged, accrual accounting ensures that income and expenses are matched in the period in which they occur.

This contrasts with cash-based accounting, where entries into the accounting system are made only when cash changes hands, and you pay or receive money.

6. Accruals

To ensure that your accounting system follows the matching principle, journal entries in your ledgers recognize revenue and expenses before they are received or paid.

For instance, an invoice for the supply of electricity to a factory in December may only be received in January.

The electricity used to produce goods for sale in December requires an accrual for the estimated amount of the invoice, recognizing the cost.

Working out your accruals forms part of every company’s tax prep checklist and is vital in ensuring an accurate tax submission.

5. Accounts Receivable

Accounts receivable (AR) refers to the money that your customers owe you for goods and services that you have supplied on credit to them.

An accounts department will create an accounts receivable aging report that lists the debtors in columns indicating the time outstanding.

The first column is for current debts and is extended to the right in 30-day increments from 30 days to 90 or 120 days.

Strict policies must be implemented to collect debt within a reasonable timeframe and collection letters and reminders set once these times are exceeded.

4. Accounts Payable

Accounts payable (AP) encompasses the money owed by your business to all your suppliers or creditors for the goods and services you’ve received.

To see how efficient your company may be in paying its debts, your accountant will calculate the accounts payable turnover ratio.

A decreasing AP turnover ratio indicates that a company is taking longer to pay off its debts and is a sign that it may be in financial trouble.

3. Accounting Period

To help determine your business’s financial health, the financial transactions are recorded and matched by your accounting system in each specific timeframe.

These periods are typically a month, quarter, or year and are used to ensure that they can be compared to previous equivalent periods.

2. Income Statement

The income statement helps to determine the net profit of your business over a set period of time – usually a month, quarter, or financial year.

It consists of net revenue or net income less the cost of goods sold to establish gross profit followed by a list of expenses.

1. Working Capital

Working capital is a figure that reflects your company’s ability to cover your short-term obligations that are payable within one year.

After deducting current liabilities from current assets, your accountant can determine whether you have sufficient resources to pay your operating expenses.

A positive working capital figure ensures that a company has enough money, while a negative figure indicates that the company is heading for trouble.

Keeping an eye on your working capital is one of the best accounting tips you can follow, as it highlights cashflow problems early on.

Summary

Now that you have a better understanding of the terminology underlying generally accepted accounting principles (GAAP), you will more easily manage your business.

Each financial transaction builds the picture of your business and makes you better able to manage the process and make more money.

You will also know what questions to ask your accountant, and they can offer you more detailed information and advice that increases your bottom line.