Boost Your Accounting Know-How with These Terms

The field of accounting has its own vocabulary, which can sound like a foreign language to some people. Your financial savvy will increase by learning a few new accounting terms. You’ll be “speaking accounting-ese” in no time, and you’ll become a smarter entrepreneur too.

Trial balance

A trial balance is an accounting report that simply lists the current balances of your accounts in your chart of accounts as of a certain date. It can also be called working trial balance. Another way to look at the trial balance is it’s a very informal version of a balance sheet.

Entity

Entity is a generic term for a company or organization. There are many types of entities: nonprofit, corporation, partnership, and sole proprietor.

Going concern

Going concern is an accounting principle. An entity is a going concern if it’s expected to continue operations in the near future.

Double entry

A double entry bookkeeping system means that when a transaction occurs, two accounts are impacted. For example, when an invoice is generated, entries are made to both the sales account and the accounts receivable account. It was invented in the 1400s and is widely used in modern accounting today.

Retained earnings

Retained earnings is an account in the equity section of the balance sheet. It’s the amount of earnings that is reinvested in the company after dividends are paid out. It’s computed by taking the retained earnings beginning balance, adding income or subtracting loss for the period, and subtracting any dividends paid.

Realization

A business transaction has many stages. It starts with an idea, may progress to a promise, then it actually happens. Accountants need to figure out when it becomes “real,” when to record it on the books. This is the concept of realization. A transaction is realized and put on the books when there is a contract, a legal obligation, an exchange of products or services, or an exchange of cash. There are many complicated principles and rules to help accountants determine this timing.

Cost principle

The cost principle is a foundational accounting principle. It means that when a transaction is booked, it is booked at cost and not market or current value. So even though an asset may have gained in value after you bought it, your books will still reflect the cost of the item, not the current value.

Client portal

A client portal is a software application where client files can be stored and retrieved securely. Both the accountant and the client have access to the portal.

Engagement letter

An engagement letter is the contract that defines the relationship between the client and the accountant. It is typically signed before the work starts and can be renewed once a year. It can also be changed if the scope of the work changes.

Matching

The matching principle is another basic accounting principle. It says that for any particular transaction, all aspects should be booked in the same accounting period. For example, let’s say you incurred expenses on an order in November. The order wasn’t delivered or invoiced until December. To meet the matching principle, the expenses should be deferred until December when they can be matched with the revenue that relates to the expenses.

Adjusting entry

An adjusting journal entry is made when account balances need to be corrected. An example is depreciation expense, which is typically booked with an adjusting entry. Accountants will make several adjusting entries like this at year-end.

Reversing entry

A reversing entry is a form of adjusting entry that is made in the period following an adjusting entry. It reverses the adjusting entry. One example of this is a cash basis taxpayer that is tracking accounts receivable. The accounts receivable balance is adjusted to zero prior to year-end and reversed on January 1.

How many terms did you already know? Now you can talk with your accountant about these concepts.

The Perfect Chart of Accounts for Your Business

Your “Chart of Accounts” is the list of accounts in your accounting software. The accounts are listed in your reports, and the totals allow you to determine how much you’ve spent, made, own, or owe depending on the type of account.

It’s essential to create a list of accounts that you need in order to make better business decisions. Your chart of accounts needs to be designed intentionally. If it hasn’t been, it’s never too late.

Two Types of Accounts

There are two major types of accounts:

Balance sheet accounts that tell what you own and owe. These are determined by your checking accounts, inventory, and credit cards.
Income statement accounts that tell you about current period operating results. These, in turn, have two major categories, income and expenses. For companies with inventory, expenses are further broken out into cost of goods sold and other expenses.

Three Purposes

A chart of accounts should meet three needs:

Make it really fast for you to do your taxes
Give you all sorts of “Aha’s”
Allow you to spend far more time on revenue analysis than expense analysis because that’s where success lies for small businesses

Taxes

Your accounts should be the same as (or be able to be grouped into) the lines on your tax return. You can find a copy of the tax form you fill out. For example, a sole proprietor will use a Schedule C of the 1040, and a corporation will complete an 1120.

There are a few special needs, such as meals and entertainment which are only partially deductible, that you need to pay special attention to. We can help you with that.

Aha

As small business owners, we work with a gut feel, but when you see what you’ve made or spent in black and white, it takes on a whole new level of meaning. Your income statement and other reports should do that for you. If they don’t you may not have your accounts set up right.

Revenue

Think about how you want to see your revenue:

By product line
By major supplier
By category of solution to the customer
By customer type
By service type
By location (you can also use Class for this)
By job
By distribution method

We can help you brainstorm based on your industry and type of business.

Actionable Intelligence

If you’ve been putting all your revenue into one revenue account, it will be exciting the first time you see your new Profit and Loss statement.

If you’ve been breaking out your revenue but it hasn’t led to any actionable change in your business, then there may be a better way to break it out.

If you’re happy with the way your revenue is broken out, then think about how you can take it to the next level.

Once you see your new chart of accounts, you will likely have even more questions. The chart of accounts can be an evolving entity, designed to serve your business needs.

Five Numbers You Should Know About Your 2016 Performance

Before we get too far into 2017, let’s take a look back at 2016 results and five meaningful numbers you may want to discover about your business’s performance. To start, grab your 2016 income statement, or better yet, give us a call to help you compute and interpret your results.

Revenue per Employee

This number measures a company’s productivity with regard to its employees and is relevant and meaningful for all industries. If you have part-time employees, compute a full time equivalent total and use that as your denominator.

Compare this number to prior years to see if your company is getting more or less productive. Also compare this number to businesses in your same industry to see how your company compares to peer companies.

You may also want to compute other revenue calculations, such as revenue by geography, revenue by product line, or average sale: revenue by customer, if you feel these may be meaningful to your business.

Customer Acquisition Cost (CAC)

How much does it cost your business to acquire a new customer? That is the customer acquisition cost and is made up of marketing and selling costs, including marketing and selling labor. You’ll need the number of new customers acquired during 2016 in order to calculate this number.

Compare this number to prior years as well as industry peers. You can potentially do a lot to lower this number by boosting your marketing skills and implementing lower cost marketing channels.

Overhead Costs

Overhead costs are costs that are not directly attributable to producing or selling your products and services. They include items such as rent, telephone, insurance, legal expenses, and executive salaries. Although it’s not standard practice to break out overhead expenses from other expenses on an income statement, it’s valuable to know the numbers for performance purposes.

Compare your overhead costs to prior years and industry averages. You can actively manage your overhead cost by re-negotiating with vendors on a regular basis and trimming where it makes sense.

Profit Margins

Your profit margin can help you determine which division of your business is most profitable. If you sell more than one product or service, you can compute a gross or net margin by product or service. You can also compute margins by geography, sales rep, employee, customer, or any other meaningful segment of your business.

Your accounting system may be able to generate an income statement by division if everything has been coded correctly and overhead has been allocated appropriately. Reach out if you’d like us to help you with this.

Seeing which service or product is most profitable can help you decide if you want to try to refocus marketing efforts, change prices, discontinue items, fire employees, attract a different type of customer, or any number of other important decisions for your business.

Breakeven Point

Do you know how many units you need to sell in order to start generating a profit? If not, the breakeven calculation can help you learn this information. The formula is Fixed Costs / (Sales Price per Unit – Variable Costs per Unit) which results in the number of units you need to sell in order to “break even” or cover your overhead costs.

The breakeven point helps you plan the amount of volume you need in order to ensure that you have healthy profits and plenty of cash flow in your business.

These five numbers can help you interpret your business performance on a deeper level so you can make better decisions that will lead to increased success in your business. If we can help with any of them, please give us a call any time.

Understanding Payment Terms

If there is a period of time between when your customers receive your goods or services and when they pay for them, then several things are true:

You have a balance in Accounts Receivable on your balance sheet that represents how much customers owe you
You have an invoice process that you follow
You have granted credit to customers
You may have some that don’t pay as quickly as you’d like them to

Each invoice you send should have payment terms listed. A payment term is the period of time you expect the invoice to be paid by the customer. Your payment terms should be set by you, not your customers!

Payment terms are always measured from the invoice date and define when the payment should be received. Here are some common payment terms in accounting terminology, and then in English.

Net 30
Payment is due 30 days from the invoice date.

2/10 Net 30
Payment is due 30 days from the invoice date. If you pay the invoice in 10 days, you can take a 2% discount off the total amount of the invoice as an early pay discount incentive.

Due Upon Receipt
Payment is due immediately

If you use Net 30 or Due Upon Receipt, then you may want to change your terms to get paid faster. When people see Due Upon Receipt, sometimes they translate it into “I can take my time.” A more specific term spelled out such as Net 7 or Net 10 will actually get you your money faster than Due Upon Receipt.

Do you have issues with people paying you late? If so, you might want to set consequences. Consider adding a line on your invoice that provides interest charges if the payment is late. Utility companies do it, and so do many businesses. A common percentage to charge is 1% – 2%, however, some states have laws that limit you to 10% or another percentage.

The wording would be something like this:

“Accounts not paid within __ days of the date of the invoice are subject to a __% monthly finance charge.”

You will also need to make sure your accounting system can automatically compute these fees.

If you have questions about payment terms, your invoicing process, or your accounts receivable, please reach out.