5 Accounting Terms You Must Know to Understand Financial Reports
Accounting has its own language. To have a meaningful conversation with your accountant, you must know the accounting terms they use. Five accounting terms you must know are:
- Net income
- Cash flow
- Accounts receivable (also called debtors)
- Accounts payable (also called creditors)
WHAT IS NET INCOME?
Net income is the same as net earnings and net profit. Net income is the total amount of profit your business makes after deducting all expenses from revenue. The expenses include the cost of goods sold, overhead and tax.
Net income is a good measure of how you are doing. A loss shows your business is not doing well. A profit is a good thing but is it good enough? You’ll need other measures to assess whether the profit your business makes is adequate.
WHAT IS CASH FLOW MANAGEMENT?
Cash flow is a term used to describe how much money is flowing in and out of your business. Whilst profit is important, a business pays its bills with cash not profit. Therefore, how much cash you have and whether it is enough to pay bills due is a concern.
Cash flow management is tracking how much money is coming into and going out of your business and acting to make sure you always have enough cash. This is important because if you can’t pay bills when they fall due, you will run into trouble with your creditors who will act to get paid.
WHAT IS AN INVOICE?
An invoice shows the details of the total price to a customer for goods or services provided. An invoice is also called a bill. An invoice should show these details:
- Quantity of any goods or services provided
- Price or rate charged
- Total cost
- Description of the transaction (so your customer knows what they’re paying for)
- When and how the customer should pay
- Tax charged.
An invoice may also show the payment terms i.e. the latest time by which payment is due. It may also provide details of the bank account to pay into.
Invoices differ from quotes. A quote provides an estimate of the price of the goods or services requested. An invoice shows the actual price or fee for the goods or services provided.
If your invoice is not correct, payment will be delayed. To avoid any delays, the invoice must be accurate. Sending written invoices is a good practice because it:
- Sets out the details of the charge.
- Shows proof of a claim for payment.
- It is an important accounting document.
WHAT IS ACCOUNTS RECEIVABLE?
Accounts receivable are invoices owed to you by customers. They’re sometimes called receivables or trade debtors. It might help to think of accounts receivable as a sales invoice that your customer hasn’t paid yet.
Let’s say you sell your product to a customer on credit and send them an invoice for the sale. The amount your customer owes you from that invoice is part of your accounts receivable. In your customer’s records, that invoice will be part of their accounts payable. In this way, accounts payable and accounts receivable are two sides of the same transaction.
WHAT IS ACCOUNTS PAYABLE?
Accounts payable refers to the bills you need to pay. They’re sometimes called payables or trade creditors.
It might help to think of accounts payable as a bill that your business hasn’t paid yet. You might owe a supplier for raw materials, for example. Or you may owe money for an unpaid electrical or phone bill.
Let’s say you buy some materials from a supplier on credit. They’ll send you an invoice for those materials. The amount on that invoice is part of your accounts payable. In your supplier’s records, that invoice will be part of their accounts receivable. Accounts payable and accounts receivable are two sides of the same transaction.
Now that you understand these five accounting terms, we believe your conversation with your accountant will be more meaningful.
SCG provides expert Accounting, Audit and Tax Advisory services to help you make sense of your business’s financial transactions and lay a solid foundation for the growth of your company.