Accounting Glossary

What is cash flow management?

Cash flow management is the process of tracking how much money is coming into and going out of your business. This helps you predict how much money will be available to your business in the future. It also helps you identify how much money your business needs to cover debts, like paying staff and suppliers.

Cash flow is the term used to describe changes in how much money your business has from one point to another. Cash flow management is keeping track of this flow and analysing any changes to it. This helps you spot trends, prepare for the future, and tackle any problems with your cash flow.

It pays to practice cash flow management often to make sure your business has enough money to keep running.

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How to calculate gross profit

To calculate gross profit, take your total sales and subtract the cost of making or selling your product.

Total sales - cost of goods sold = gross profit

Let’s say your business sells $12,000 worth of your product, and it cost you $8,000 to make those products. This would leave a gross profit of $4,000.

$12,000 total sales - $8,000 cost of making the product = $4,000 gross profit

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What is a profit and loss statement?

A profit and loss statement shows how much your business has spent and earned over a specified time. It also shows whether you’ve made a profit or a loss over that time. This shows whether your business has made a profit or loss during that time – hence the name. A profit and loss statement might also be called an ‘income statement’, a ‘statement of operations’, a ‘statement of earnings’ or a ‘P&L’.

A profit and loss statement shows all your revenue and expenses. This includes things like payroll, advertising, rent and insurance. It will also show your earnings from sales and other forms of income.

Your total profit or loss for the time period you’ve chosen is what you’ve earned minus what you’ve spent. If this amount is positive, it’s called a net income. If it’s negative it’s called a net loss.

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What is the difference between bookkeeping and accounting?

Bookkeeping and accounting are both important parts of managing your finances. At first glance, the two can seem quite similar, but there are a few main differences.

Bookkeeping focuses on recording and organising financial data. Accounting is the interpretation and presentation of that data to business owners and investors.

Bookkeeping typically consists of:

payroll
invoicing
receipts and bills
recording business transactions.

Accounting typically consists of:

financial statements and reports
budgets
tax returns
analysing business performance.

The tasks that bookkeepers and accountants do vary between businesses. Bookkeepers working for smaller businesses might do some basic accounting duties. There’s often overlap, and the duties may change a lot from one business to another.

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What is net income?

Net income is the total amount of profit your business makes after deducting expenses. This includes:

the cost of goods sold
overhead
tax

Net income is a good way of measuring how profitable your business is. Annual net income is your net income for one year.

Net income is also called net earnings and net profit. Because it’s on the last line of an income statement, it’s also known as ‘the bottom line.’

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What is an invoice?

An invoice is a document that charges a customer for goods or services you’ve provided. Also called a bill, an invoice shows all the information about a transaction. This includes:

the quantity of any goods or services provided
the rate charged
the total cost
a description of the transaction (so your customer knows what they’re paying for)
when and how the customer should pay

Invoices differ from quotes. A quote provides an estimated cost. An invoice shows the actual time taken and actual cost of a job or transaction. For a customer, the invoice is a “purchase invoice.” For a supplier, it’s called a 'sales invoice'.

Another function of an invoice is to remind your customer that they haven’t paid you yet. Larger companies may lose track of payments if they deal with many suppliers at once. For this reason, an invoice shows your customer when they should pay you. This is called a payment term. This might be 7 days, 14 days or even a month depending on the agreed terms. It’s often written as 'Net 14 days'.

Invoices should always be accurate, descriptive and timely. This is vital to keeping a steady cash flow for your business.

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What is business accounting?

Business accounting is the systematic recording, analysing, interpreting and presenting of financial information. Accounting may be done by one person in a small business, or by different teams in large organisations.

Accounting is the way a business keeps track of its operations. Accountants analyse the business finances so the owner can make better decisions. This information is organised into reports that show the financial health of a business.

Accounting helps business owners meet their compliance obligations. It also helps them make smart decisions with their money.

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What is the objective of financial reporting?

The objective of financial reporting is to track, analyse and report your business’ income. The purpose of these reports is to examine resource usage, cash flow, business performance and the financial health of the business. This helps you and your investors make informed decisions about how to manage the business.

There are three main goals of financial reporting:

Provide information to investors
Investors will want to know how cash is being reinvested in the business, and how efficiently capital is being used. Financial reporting helps investors decide whether your business is a good place for their cash.
Track cash flow
Where is your business’ money coming from? Where is it going? Is the business making a profit or a loss? These answers are important to know – they show how well your business is performing, and whether it can cover its debts and continue to grow.
Analyse assets, liabilities and owner's equity
By monitoring these, and any changes to them, you can work out what to expect in the future, and what you can change now to prepare. This also shows the availability of resources for future growth.

Financial reports adhere to a group of taxation, accounting and legal requirements, called the International Financial Reporting Standards. This is so a business’ finances can be understood all over the world – a necessity with the increase of global companies and international shareholders.

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What is a cash flow statement?

A cash flow statement is a financial report that shows where your money is coming from and where it’s going. It’s also known as a ‘statement of cash flows’ or a ‘CFS’.

At first glance, a cash flow statement looks similar to an income statement. But cash is different to income – cash only includes spendable money. Income includes fixed term assets, long term assets and sales made on credit.

Cash flow statements show whether you’re able to cover short term expenses like bills and staff wages. It is also useful for investors, as it shows how well your business can bring in money.

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What is financial management?

Financial management is strategically planning how a business should earn and spend money. This includes decisions about raising capital, borrowing money and budgeting. Financial management also involves setting financial goals and analysing data.

Financial management starts with recording all the money your business earns and spends. Accountants then prepare reports that help owners understand the financial health of their business. These include profit and loss statements, balance sheets, cashflow statements and budgets.

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What is bank reconciliation?

There can be times when your financial records might not be the same as your bank’s. Bank reconciliation involves comparing these records and identifying any differences between the two. This is important for keeping track of your business’ money.

There are a few reasons the balance on your records may not be the same as the bank’s:

When someone hasn’t yet cashed a cheque you’ve sent: The money owed from that cheque is still in your bank account – but it’s no longer yours to spend.
Changes to bank accounts at the end of a month: This can happen when you withdraw or deposit money just before the bank sends a statement. Those changes to the account might not show until the following month’s statement.

The bank deducts loan payments: The bank can deduct money for loans before you enter that information into your systems.
Deposits in transit: Deposits you’ve made and recorded in your books that haven’t yet processed through the bank.

Bank reconciliation helps you identify these cases so you know exactly how much money is available to your business. It’s also needed to identify any cases of human error, bank charges and possible fraud.

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How to calculate net profit margin

Your net profit margin shows what percentage of your sales is actual profit. This is after factoring in your cost of goods sold, operating costs and taxes. To calculate your net profit margin, divide your net income by your total sales revenue.

Net income ÷ total sales = net profit margin

The result is your net profit margin. You can multiply this number by 100 to get a percentage.

Let’s say your business makes $12,000 in sales, it cost you $8,000 to make your products, and you spent another $2,000 on operating costs (such as overhead and taxes).

Total sales - (cost of goods sold + operating costs) = net income
$12,000 - ($8,000 + $2,000) = $2,000

Net income ÷ sales = net profit margin
$2,000 ÷ $12,000 = 0.1667

0.1667 × 100 = 16.67%

In this example, your business would have a net profit margin of 16%. In other words, 16% of your total sales revenue is profit.

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What is accounts payable?

Accounts payable refers to the bills you need to pay. They’re sometimes called payables or AP.

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. In your records, 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. In this way, accounts payable and accounts receivable are two sides of the same transaction.

Accounts payable might also refer to the person or team who processes invoices and pays your bills. A supplier who hasn’t yet received payment for the goods they’ve provided might want to talk to 'accounts payable'.

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How do I make an invoice?

Creating accurate invoices is important if you want to get paid on time. To make an invoice, you need to provide the details about a transaction you’ve made with a customer. This includes:

a description of the product or service you provided
how much the customer owes you
how and when they should pay

The easiest way to make an invoice is to use a good accounting software. Your invoice should include the following items:

1. Business name and logo: This shows your customer that the invoice is from you. If your business is registered for VAT, you also need to make it clear this is a tax invoice. If not, it’s a regular invoice.

2. Your contact details: A phone number, email address and physical address.

3. Your customer’s contact details: A phone number, email address and physical address.

4. An invoice number: This is important if you send more than one invoice to the same customer.

5. The date: The date the invoice was issued.

6. The details of the transaction: This reminds your customer what they’re paying for. Provide a description of what you provided the customer, and when the transaction happened:

If you provided a service:

the amount of time you worked
the rate you charge
the total price of the job

If you sold a product:

the quantity of products sold
the price of each product
the total price of the transaction

7. The total price: Remember to add any extra fees, such as delivery fees and tax to the total.

8. Invoice payment terms: This is the time period you want your customer to pay within. Anywhere between 7 and 30 days is standard.

9. Preferred payment method: This might be cash, cheque, direct credit or PayPal.

10. Any late payment fees or early payment discounts.

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What is accounting software?

Accounting software is software that does various accounting and bookkeeping tasks. It stores a business’ financial data, and is often used to perform business transactions.

Most modern accounting software is always connected to the internet. This means you can connect from any internet-capable device, like your laptop or smartphone. This online space where you can access your data is called the cloud. Online accounting software automatically receives and updates because it’s always connected to the internet.

Different kinds of accounting software do different things. Most of them automatically enter, store and analyse data for you. This is especially useful for saving time on tasks like bank reconciliation. Accounting software also offers useful tools like invoicing, bill payment, payroll, and financial reporting.

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What is working capital?

Working capital is the amount of cash your business has after factoring in your short term debts. Your working capital is your current assets less your current liabilities.

Your current assets
include:

cash (and cash
equivalent items)
accounts receivable
prepaid expenses
inventory

Your current liabilities
include:

accounts payable
payroll
loans and debts
unpaid taxes

Let’s say you have $5,000 of current assets and $4,000 of current liabilities. This means you have a working capital of $1,000.

Current assets - current liabilities = working capital

$5,000 current assets - $4,000 current liabilities = $1,000 working capital

Working capital is a good way to judge the financial health of your business. This is useful because:

it helps you see how well your business is performing
it tells investors if your business is a good place for their money

If your working capital is low, your business might struggle to grow. But your working capital can also be too high – which is a sign you’re not properly reinvesting your cash. Keep in mind how soon you can turn your assets into cash. Even businesses with large amounts of working capital might have poor cash flow if they struggle to convert assets to cash.

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What are pay stubs?

A pay stub is a document that’s given to an employee with each paycheck. It shows their total wages earned for a set period. This might be from a salary, hourly wages or commission.

Pay stubs also lists any tax withheld and personal deductions made. This include insurance and pension contributions. Pay stubs are also known as ‘pay slips’, ‘paycheck stubs’, or ‘pay advice’.

Traditionally the pay stub was a paper document attached to a physical check. Today, most employers prefer to use electronic pay stubs.

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What is a financial statement?

A financial statement is a report that shows the financial information of a business. There are four main types of financial statement:

Balance sheet: a snapshot of your business’ financial condition at a single point in time, such as 31/12/2016. Shows your business assets, liabilities and owner's’ equity at that time.
Profit and loss statement: also called an income statement. Shows your business’ revenues, costs and expenses over a period of time, such as 1/1/2016 to 31/12/2016.
Cash flow statement: also called a statement of cash flows. Shows changes to the cash coming into and going out of your business over a period of time. Only records cash (not all income). Shows whether you can cover short term expenses like bills and payroll.
Statement of changes in equity: also called a statement of retained earnings. Shows changes in the equity of your business for a set time period. In other words, changes in how much money your business keeps (rather than pays out to shareholders).

Combined, these statements provide a good view of the financial health of your business.

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What is gross profit?

Gross profit is the amount of money your business makes from sales after deducting the cost of making and selling your product. This amount is before you pay operating costs, payroll, tax and overhead.

Gross profit reflects how profitable a product is. The less it costs to make, and the higher you can sell it for, the larger your gross profit will be. Gross profit is also known gross income, and appears on the income statement.

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What is accounts receivable?

Accounts receivable are invoices owed to you by customers. They’re sometimes called receivables, trade debtors, or AR. 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.

Accounts receivable might also refer to a person or team in charge of receiving or chasing up payments owed to your business. Your 'accounts receivable' might want to talk to a customer who is overdue on their payment to you.

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What is sole proprietorship?

Sole proprietorship is a type of business with only one owner. The owner has complete authority over every aspect of the business.

A sole proprietorship is not a separate legal entity – it’s considered an extension of the owner. But you can operate under a business name, like “Bob Smith Plumbing.”

Sole proprietorships are easy to set up. Because the business uses your individual tax code, you don’t need to register as a business. But depending on your industry you may need a license – such as a food and liquor license, or an admission to practice law.

Sole proprietorship taxes are easy, because all income the business earns is treated as personal income. But this also means the owner is accountable if the business runs into financial trouble, like debt or bankruptcy. The owner’s personal assets can also be at risk if a claim is made against the business – for faulty workmanship or malpractice, for instance.

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What is a commercial invoice?

A commercial invoice is a document used in international shipping. It gives information about the product being sent, including:

what the item is
the seller and buyer
the date and terms of the sale
the quantity and weight
the value of each individual item
the total value of the package
any insurance and shipping costs

Customs officials use commercial invoices to work out the value of the goods being traded. This is so they can work out tariffs, which are taxes imposed on imported goods.

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What are fixed assets?

Fixed assets are any assets that cannot be easily converted to cash. They are typically tangible, physical things that have an economic life of longer than a year. These include buildings, vehicles, furniture and office equipment. Fixed assets normally don’t include intangible things like royalties and brand names.

Fixed assets are also known as non-current and long-term assets. They may also be referred to as property, plant and equipment. They are assets intended to be used within the business, not sold or converted to cash.

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Accounting Glossary

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Accounting Glossary