Hiring an accounting professional is considered best practice for small business owners. But delegating financial analysis and reporting doesn’t mean completely checking out of the process each month or quarter.
On the contrary, you as a business owner should work closely with the accounting professionals on your team throughout the year. This helps you to:
- better understand your financial position, and
- make smart plans for future growth.
You don’t need to take an accounting course to remain engaged with the accounting side of your business, but you do need a little accounting knowledge to have more informed, insightful discussions with your accountant or bookkeeping professional.
Make sure you have the basics down with this list of 6 essential accounting terms for small business owners.
1. Cash Flow
Do you have more cash flowing into your business each month than you pay out to cover costs and expenses?
If so, your accountant will conclude that you’re “cash-flow positive.” If the opposite is true, your cash flow statement will reveal that you’re “cash-flow negative.”
Having excess cash on hand means you’re better equipped to keep up with debt, cover unforeseen expenses, and invest in growth opportunities. Your accountant will generate a cash-flow statement each quarter to keep tabs on this key performance indicator.
2. Profit and Loss Statement (P&L)
The profit and loss statement (also known as the income statement) is one of the most important documents used by accounting professionals to determine the profitability of your business.
The P&L lists revenues and gains as well as expenses and losses over a specific period of time (typically every three months for small businesses). It calculates your all-important “bottom line,” so you know if you’re operating at a loss or turning a profit.
3. Gross vs. Net Profit
Gross profit is what remains when you subtract the cost of goods sold (COGS) from your total revenue.
Net profit, on the other hand, drills deeper. It reveals what’s left after subtracting all operating expenses, including COGS, taxes, interest paid on debt, etc.
Gross and net profit are both profitability ratios. They are key for measuring business performance against an industry benchmark and your competitors.
4. Balance Sheet
The balance sheet offers a snapshot of your overall financial position at a particular moment in time. It lists the assets (cash, inventory, accounts receivable, equipment, etc.); liabilities (like accounts payable, income tax, and payroll taxes); and shareholder capital.
In a nutshell, the balance sheet shows what you own and what you owe.
A Profit First Professional uses the balance sheet, the P&L, and the cash-flow statement to create a detailed Profit Assessment Report, which shows which healthy-business targets you’re reaching, and how to get to the ones you’re not. Your Profit First Professional will help you create a plan to ensure your business is consistently making a profit.
5. Accounts Receivable & Accounts Payable
Simply put, accounts receivable is money your business is owed by customers for goods or services sold. It is considered an asset on your balance sheet.
Conversely, accounts payable is money you owe suppliers and any bills you have yet to pay, so it’s listed as a liability on your balance sheet.
6. Bad Debt Expenses
If long-term outstanding accounts receivable cannot be collected (your customer refuses to pay or goes bankrupt and can’t pay you), they will be written off as a loss called a “bad debt” expense on your P&L.
And there you have it: 6 key terms to help you build your accounting vocabulary, join the conversation, and empower smarter decision-making.
If you don’t yet have an accounting professional on your team to help you keep the pulse on your business, let us know if we can help.
In your corner,
The GuYDanS Team