Accounting 101: Key Terms Every Beginner Should Know

Accounting plays a crucial role in any business. By tracking income, expenses, assets, liabilities and other financial transactions, accounting provides insights into the health and performance of a company.

Whether you‘re an entrepreneur looking to better understand your finances or interested in a career in accounting, mastering some key terms and concepts is the first step.

The Importance of Accounting

At its core, accounting is about tracking what comes in, what goes out, and where the money is. With quality accounting, some key questions can be answered:

  • Is the company profitable?
  • Where is money being wasted?
  • Are there enough assets to cover expenses?
  • Is growth and cash flow healthy?

Equipped with data around these questions, business leaders can make strategic and informed decisions. The fate of many companies comes down to the accuracy of its accounting.

Key Accounting Concepts

1. Assets

Assets are tangible or intangible items of economic value owned by a company, such as:

  • Cash
  • Accounts Receivable
  • Inventory
  • Patents
  • Property
  • Equipment

2. Liabilities

Liabilities represent financial obligations that a company owes to outside parties, usually arising from past transactions. Common examples include:

  • Loans
  • Unpaid Invoices
  • Wages Payable
  • Unearned Revenue
  • Notes Payable

3. Equity

Equity represents residual ownership and claims on total assets. It arises from contributions made by investors plus retained profits. For example:

  • Common Stock
  • Preferred Stock
  • Retained Earnings
  • Shareholder Contributions

4. Revenue

Revenue represents income earned from key operating activities, usually from the sale of products and services. Some examples include:

  • Product Revenue
  • Service Revenue
  • Membership Fees
  • Interest Income

5. Expenses

Expenses represent costs required for operating a business, such as:

  • Wages & Salaries
  • Rent
  • Utilities
  • Supplies
  • Depreciation

Key Financial Statements

Financial statements are used to provide an overview of a company‘s finances, usually prepared on a quarterly and annual basis.

1. Balance Sheet

A balance sheet shows a snapshot of assets, liabilities and equity at a specific moment. It follows the accounting equation: Assets = Liabilities + Equity.

2. Income Statement

An income statement summarizes revenue and expenses over a period, ultimately arriving at net profit or loss for the company over the period reported.

3. Cash Flow Statement

The cash flow statement breaks down cash inflows and outflows into operating, investing and financing activities. This helps explain changes to the company‘s cash balance.

Debits and Credits

In double-entry accounting, every financial transaction is recorded with equal debit and credit amounts to balance the books. This provides a check and audit trail.

Debits:

  • Increase Asset accounts
  • Decrease Liability accounts
  • Decrease Equity accounts
  • Record Expenses

Credits:

  • Increase Liability accounts
  • Increase Equity accounts
  • Decrease Asset accounts
  • Record Revenues

Key Accounting Terms and Concepts

Accounts Receivable

Amounts owed by customers for goods or services delivered on credit.

Accounts Payable

Amounts owed to vendors or suppliers for goods or services purchased on credit.

Accrual Basis

Method of accounting where revenue is recorded when earned and expenses when incurred, not necessarily when cash changes hands.

Amortization

Gradual reduction of an amount owed over multiple accounting periods, similar to depreciation of assets.

Audit

Examination of accounting records and practices to ensure compliance, accuracy and detection of fraud.

Book Value

Value of an asset on the balance sheet, equal to historical cost minus accumulated depreciation.

Capital Expenditures

Funds used to acquire, maintain or improve fixed assets like property and equipment.

Cash Basis

Method where revenue and expenses are recorded when actually received or paid out in cash.

Cash Flow

Net movement of cash into or out of a business during an accounting period.

Chart of Accounts

Complete listing of accounts used to record accounting transactions, typically arranged in order of appearance on financial statements.

Contra Account

Account with a balance opposing normal balances of its related primary accounts.

Cost of Goods Sold

Direct costs attributable to goods or services sold to customers.

Credit

Right side entry representing additions to liabilities, equity and revenue accounts or reductions in asset accounts.

Debit

Left side entry representing additions to asset and expense accounts or deductions from liabilities, equity and revenue.

Double Entry

Method where each financial transaction is recorded with equal debits and credits to balance the books.

Exchange Rate

Rate at which one currency is converted into another currency.

FIFO

"First In, First Out" cost flow assumption where earliest acquired inventory items are first sold.

Fiscal Year

Annual period used for accounting reporting and preparing financial statements, not always aligning with the calendar year.

General Ledger

Master record organizing and summarizing all financial transactions over the lifecycle of a company.

LIFO

"Last In, First Out" cost flow assumption where most recently acquired inventory items are recorded as sold first.

Payroll

Total wages, salaries, bonuses, commissions and benefits paid to employees, including all employment tax requirements.

Trial Balance

Report with ending balances for all accounts to ensure the total debit balances equal total credits, serving as a preliminary check before financial statements are prepared.

And hundreds more terms defined…

Accounting Roles and Responsibilities

Various accounting roles divide up essential responsibilities:

Bookkeepers

Record day-to-day financial transactions, maintain ledgers, process payroll, invoice clients, manage payables and receivables.

Accountants

Analyze transactions, propose accounting adjustments, produce financial statements, ensure accuracy of books and compliance with GAAP principles.

CPAs

Certified Public Accountants who audit financial statements to verify reporting accuracy and compliance with accounting standards.

Controllers

Maintain general ledger, produce financial statements, direct accounting operational activities, manage budgeting and forecasting, analyze results.

CFOs

Chief Financial Officers oversee all financial operations and accounting procedures, guide vital financial decisions around growth, risk and funding.

Accounting Methods and Technology

Inventory Valuation

Determining the cost of goods sold expense, inventory methods like FIFO and LIFO assign costs to units sold based on assumptions of when they were acquired to properly match against revenue.

Automation

Advanced accounting software automates tasks like transaction processing, report generation financial consolidations, improving efficiency and cutting tedious manual work.

ERP Systems

Robust Enterprise Resource Planning integrated systems manage core processes across accounting, HR, inventory, manufacturing, even customer relationship components.

Cloud Computing

Harnessing cloud technology allows accounting platforms to scale flexibly, share information securely online with finance teams and connect various software solutions.

Accounting Best Practices

Following standards like Generally Accepted Accounting Principles (GAAP) leads to ethical accounting and sound reporting practices crucial for business success.

Internal Controls

Processes ensuring transactions are properly approved, valid, free of error and secure from fraud like theft or embezzlement.

External Audits

Unbiased examination of financial statements by an independent CPA provides transparency and assures all stakeholders the information can be trusted.

Financial Analytics

Using performance metrics around profitability, asset utilization, liquidity and leverage guides strategic decisions to fuel growth and returns.

This overview provides a foundation for accounting‘s essential concepts and terminology. Mastering the basics opens the door to pursuing a fruitful career keeping the books and finances of almost any company.