Don’t be that business owner that says gross profit when what you really mean is gross margin.
Why is it important as a business owner to know the basic accounting terms?
If you’re mixing up terms like gross profit with gross margin it makes communication with your accounting services more difficult and more importantly, it makes you look bad to potential investors.
Familiarize yourself with these basic accounting terms so you can talk the finance talk.
What are the basic accounting terms?
The 28 “Need-to-Know” Accounting Terms Are:
1. Accounts Payable
Money owed by your company.
Money due to your company.
3. Accrual-Basis Accounting
Expenses you account for when the expense occurs not when the cash is paid, and accounts receivable accounted for as assets before the cash is received. Accrual-basis accounting allows for a better measure of the profitability during a specific window of time.
Assets are items of value owned by your business which can include: cash, accounts receivable, inventory, investments, ownership of land or buildings, equipment.
The balance sheet is a financial statement that should reflect your company’s assets, liabilities, and capital at a specific time while listing the income and expenditure before that time. This statement is important for potential investors to determine the liquidity of your business. The formula for your balance sheet is assets = liabilities + stockholder equity / capital at a certain point in time. The balance sheet is typically reported on a monthly, quarterly or annually basis.
6. Cash Disbursements
Any outgoing cash payments made for things related to your business’ operating expenses, capital expenditures or interest on loans for example.
7. Cash-Basis Accounting
As opposed to accrual-based accounting (see number 3), cash-basis accounts for revenue and expenses when the cash is physically received or paid.
8. Churn Rate
In simple terms, the rate at which customers stop supporting your business. Often seen as an important Key Performance Indicator (KPI) for Service as a Software (SaaS) business models, it is especially useful for looking at the rate at which customers end their subscriptions within a certain time. Generally, you want your growth rate to exceed your churn rate in order to scale.
9. Cost of Goods Sold (COGS)
The total direct cost to produce and sell your goods. This total should include all direct labor, materials and supplies and any overhead you incur. You want to know and understand your COGS as it is directly related to knowing your gross margin (see number 13). If you can lower your COGS, you increase your gross margin, and increasing your gross margin = awesome!
A KPI measuring the cost to your company for acquiring one customer called your CAC for short.. Although we are happy to crunch these numbers for you, you can find the formula and read more about KPIs for Growth here.
The excess value of your business assets above the value of the business liabilities. If you have more liabilities than assets, then you have negative equity. Use our convenient debt-to-equity ratio calculator to determine your solvency.
12. Financial Statements
13. Gross Margin
A percentage value found from the difference between your revenue and COGS.
14. Gross Profit
Not to be confused with your gross margin, gross profit is a dollar amount found from your net sales minus your COGS.
15. Income Statement
Sometimes referred to as the Profit & Loss (P&L) statement, your income statement reflects your financial performance over a certain period of time. It includes all revenue and expenses and any net profit or net loss over the same period of time.
16. Inventory Turnover
The number of times inventory is sold within a specific time period. It is found from your COGS divided by the average inventory.
Any financial debt or obligation your company has. For example, accounts payable, mortgage or accrued expenses. We often see liabilities overlooked in startups and small- to medium-sized businesses that have yet to hire an outsourced CFO to look after their books! And, a reminder that if you are not correctly accounting for your liabilities, then your balance sheet is also incorrect. That spells a problem for investors or your stakeholders.
18. Lifetime Value
Lifetime Value (LTV) is the value given to the estimated profit gained from a customer during that same customer’s “lifetime” as your customer.
19. Net Cash Flow
The actual amount of cash made or lost within a specific period of time. Cash flow is an important valuation component to investors because you cannot fake it, unlike other metrics like price to earnings ratio, which can be manipulated.
20. Net Profit
The actual profit after all expenses during a specific period of time.
21. Operating Expenses
Expenses that your business incurs from its main operating activities that are reported on your income statement including the production of your goods or services, salaries, insurance and rent.
22. Payback Period
Surprise! We’ve got a whole blog post on this particular KPI. Your Payback Period (PBP) is the length of time required to earn back the cost of your investment. A shorter PBP means more profit cycles within a specific time period which means less capital needed to fund your growth!
23. Price to Earnings
Your price-to-earnings ratio is often (mistakenly) thought to be the most important ratio to focus on to impress your investors. While it is a ratio that determines your share price or stock relative to your earnings, remember that being profitable is not the same as being cash-flow positive.
Your income statement, commonly referred to as the P&L. Your profit and loss statement reflects your financial performance over a certain period of time. It includes all revenue and expenses and any net profit or net loss over the same period of time.
25. Recurring Revenue
Any portion of your revenue that is likely to continue or repeat. This is not relevant to all business models, of course, but it is good to be aware of it as it is the most predictable of models over time. So, even if all your revenue is not recurring, if you can find a way to have a portion of your earnings recur, then you are setting up your business in a very stable way.
26. Return on Investment (ROI)
The benefit to a shareholder from investing in your business. A high ROI is good for your investors.
Income from your business’ goods or services.
28. Trial Balance
A statement or report that lists all income statement and balance sheet balances you hold (debits or credits), noting anything without a balance of zero. This should help catch any accounting errors if, for example, debits do not equal credits. (Which never happens right?!)
This isn’t a complete list of accounting terms, of course; it simply includes the ones we deem the most important for high-growth entrepreneurs. We aren’t trying to write ourselves out of a job here, either, we just know that if you have a solid understanding of these basic accounting terms then we can do an even better job of getting your books ready to scale! Need help balancing your debits and credits? We’re here to help, check out our virtual accounting services to see what package might meet your needs today.