Top 10 Most Confusing Accounting Terms and Their Definitions
#1 Balance Sheet vs. Income Statement
One of the more confusing aspects of accounting is getting the statements correct. The balance sheet is a statement of a company’s financial position at a “snapshot in time” including assets, liabilities, and the equity of a company. The income statement is also known as the profit and loss statement because it takes total revenues minus expenses during a given period.
Depreciation is a method of allocating the cost of a tangible asset over its useful life. For your taxes, it is considered an income tax deduction. For tax purposes, the MARCS method of depreciation is used and you must use Form 4562 in order to report it on a tax return. If you need help with this process you’re in luck because we’re experts!
#3 Accounts Receivable vs. Accounts Payable
When you have supplied customers with your goods or services and have not had the money come back to you, this is known as your accounts receivable. The balance of this account can be found on a balance sheet (explained above) as a current asset. Whereas accounts payable is the account where you have received goods or services from an outside source and you have not paid them yet. This can also be found on the balance sheet but as a current liability.
The basic idea of accruals is accounting for something that has not been earned or paid yet. A basic example is the idea of utilities. You use water and electricity, but don’t pay for it until the end of the month. You can guess how much you will need to pay based off of past months, so you would accrue a cost of the utility of what you will have to eventually pay.
#5 Fixed vs. Variable Expenses
Fixed costs are costs that will not change due to changes of production levels. Such as rent, insurance, subscription due, etc. Variable costs are costs that will be impacted on how many items are produced. Some examples include materials, wages, shipping costs, etc.
#6 Cash Flow
It is a measure of how much cash and cash-equivalents are moving into and out of a business. Positive cash flows are good because it indicates a company’s liquid assets (cash) are increasing. Negative cash flow means the inverse of cash moving in. This isn’t always a bad thing, but it usually means that a company’s liquid assets are decreasing. These changes can be used to tell a company’s solvency and if they are handling their money wisely for the long-term.
#7 Net Worth
Net worth is calculated by taking all of your assets you own and subtracting the liabilities you are responsible for. A consistent increase in net worth shows your business is in good financial health. This can also be known as book value or shareholder’s equity.
Equity is the amount you own, whether that be of a business you have stock in or a business in which you own. As a simplified example, say you own a car that is worth $20,000 but you still owe $15,000 on it, the car represents $5,000 equity. Equity can also be easily calculated as assets – liabilities.
Amortization, similar to depreciation, is the systematically spreading out of intangible asset costs or capital expenses over a specific period of time. This spreading reflects the company’s consumption of that item.
What is a CPA? And what do they do that’s so important? Well CPA stands for Certified Public Accountant and they are very important when it comes to tax time. To become CPA certified you have to have passed the series of CPA Exams and that is no easy feat. CPA professionals add value to their clients by preparing and analyzing financials, tax planning strategies, and providing investment advice. They are also able to properly file documents to government agencies when tax time comes around and that is very important for you as a client.
These are some terms that we believe to be the most confusing when it comes to owning your own business or just wanting to be in the world of business overall. We are more than happy to help with any questions you may have regarding your business or personal needs.