The language of accounting
Accounting is sometimes called the language of business. And it really is a language, with its own names and terms for the transactions and reports that make it up. I believe it's really important we at least understand the terms that we will be hearing so we can confidently take part in the financial conversations!
All of the following terms will feature in a full set of financial statements ("the accounts"), and will be expressed as a monetary figure - i.e. in £ or $.
The key terms you need to know
These are the most important words in accounting, for now at least. It is not an exhaustive list - we'll be adding to it as we learn more about accounting, but get your head around these first!
Profit:
Sometimes referred to as the bottom line, the number one objective for any business is to be profitable. Without profit a business isn’t a business, it’s a charity. Profit is the excess of income of a business over its expenses. It is calculated for a period of time, for example the profit for March would be March’s income less March’s expenses.
Income:
The ‘top line’ for a business - income refers to the money earnt by the business. Income can come from a variety of sources. Revenue or sales income will be generated by selling the key products / services of the business, whilst interest income may be money earnt from business cash held in a savings account.
Expenses:
These are the costs incurred by a business in a period. They can be cash expenses or accounting expenses (eg depreciation - more on that in future)
Costs:
Another term used for expenses. More common when looking at management information
Revenue:
Income from selling your (normal) goods and services.
Sales (sales income):
Another term for revenue. The value of what you have sold!
Cost of goods sold (cost of sales):
The costs/expenses associated with buying, producing or supplying your normal goods and services. E.G. The costs of buying the material to make your product is a cost of goods sold. The delivery costs getting that material to you is a cost of goods sold. Marketing and banking costs are not costs of goods sold, they are operational costs.
Gross profit:
What I like to call “top profit”. This is your revenue (or sales income) less the direct / indirect costs associated with the actual goods / services sold - the “cost of goods sold” or “cost of sales”.
Net profit:
This is your “bottom profit”. This is all income less all expenses.
Operating profit:
Can sometimes be the same as net profit, it might be somewhere between gross profit and net profit - it will depend on the business and how expenses are categorised.
Payables:
Also known as creditors. These are the suppliers from whom you have bought goods or services on credit, or under a use now, bill later scenario (e.g. electricity or usage based services). You owe payables money.
Receivables:
Also known as debtors. These are customers who have bought from you or used your goods or services, but not yet paid you in full / paid you at all (i.e. have purchased from you on credit). Receivables owe you money.
All of the above terms will be shown with the financial statements of the business.
The main financial statements
There are two main statements to be aware of, which is where the above items will be presented.
Statement of Profit and Loss (AKA P&L or Income Statement):
The primary job of this statement is to tell you about the performance of the business. So it will tell you whether or not you have made a profit or a loss (or both!) for a period. It lists out all of the income and all of the expenses (often grouped by category) for a period, and sums them up to give, the profit or loss for the period!
Statement of Financial Position (Balance Sheet):
The primary job of this statement is to tell you about the position of the business (imaginative naming huh?!). It will list out everything the business has (owns) and what it owes, to both third parties (owes) and back to the owners. Officially this is a list of the assets, liabilities and equity (owners capital) at a specific point in time, normally the end of the accounting period the P&L covers.
Have you met a term you don't understand? Let me know what you've got stuck on!