Small Business Accounting: Terms You Need to Know

Starting a small business is a long (and sometimes scary) process that includes everything from brainstorming and research to planning and finally getting your idea off the ground. And, while accounting is a crucial aspect of running a business, it wasn't likely what drew you to start one in the first place.

Starting a small business can be an exciting and challenging journey. While accounting may not be the reason you decided to start your own business, it plays a crucial role in its success. Hiring an accountant can alleviate the stress of bookkeeping, payroll, and taxes, allowing you to focus on other important aspects of your business. However, it’s essential not to neglect your financial responsibilities and instead work closely with your accountant to gain a better understanding of your business’s financial situation and plan for its future.

To enhance your accounting knowledge and improve your business’s financial well-being, it’s important to familiarize yourself with some basic accounting terms. Here are a few terms every business owner should know:

Cash Flow

Cash flow refers to the amount of money coming in and going out of your organization. If your business has more cash flowing in each month than what is paid out for bills and expenses, you are considered “cash flow positive.” This positive cash flow enables you to handle debts, unexpected expenses, and explore growth opportunities. On the other hand, if money is flowing out faster than it’s coming in, your cash flow statement will show that you’re “cash flow negative.” Keeping track of cash flow is crucial, and you can ask your accountant to prepare a cash flow statement regularly to stay on top of it.

Profit and Loss Statements

Also known as the income statement or P&L statement, the profit and loss statement is a fundamental document used by accountants to assess the profitability of your business. It summarizes a company’s revenues, gains, expenses, and losses over a specific period (annually, quarterly, or monthly). The P&L statement provides a snapshot of whether your business is making money or losing money, making it a valuable indicator of your company’s management and operations.

EBITDA

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a commonly used measure to evaluate businesses. By taking your net income and multiplying it by the interest expense, tax expense, and depreciation expense, you arrive at your EBITDA. This figure provides a clearer view of how much money your company generated before spending it on non-operating items. EBITDA allows for a more objective comparison between businesses in the same industry, as it excludes subjective factors that may impact net income, such as indebtedness, various tax brackets, and capital expenditures subject to depreciation.

Balance Sheet

The balance sheet provides a snapshot of your business’s overall financial position at a specific point in time. It presents a company’s assets (cash, inventory, accounts receivable, equipment), liabilities (accounts payable, income taxes, employee salaries), and shareholders’ equity. In essence, the balance sheet showcases what your business owns and what it owes.

Accounts Payable and Accounts Receivable

Accounts payable represents the bills and invoices that your business needs to pay for expenses that haven’t been settled by the end of a particular period. It represents the money you owe to suppliers and any outstanding invoices. Accounts receivable, on the other hand, represents the money owed to your business by clients who haven’t yet made payment. While accounts receivable is recorded as an asset on your balance sheet, it’s important to handle bad debt carefully. If you’re unable to collect payment from customers, it becomes a bad debt and needs to be written off as an expense on your balance sheet.

Trial Balance and General Ledger

The trial balance is a list of all the accounts that comprise your balance sheet and income statement. It shows the final balance of each account at a specific point in time, typically the end of the year. On the other hand, the general ledger contains detailed information about each transaction that passed through each account, including the date it occurred. Think of the trial balance as your “bank balance” and the general ledger as your “bank activity.”

Operating Versus Capital Expenses

Operating expenses are the items on which your business spends money to operate, such as the cost of goods sold, administrative expenses, and research and development. They appear as expenses on your income statement and are used for one year or less, typically costing less than $1,000. Capital expenses, on the other hand, are reported as assets on your balance sheet and are generally kept for longer than a year. They include items like computers, furniture, and automobiles. Capital assets are depreciated over their useful lives, resulting in a recurring depreciation expense on the income statement. Understanding the distinction between operating and capital expenses helps you track and manage your business’s costs effectively.

Fiscal Versus Calendar Year

A calendar year is the year that follows the standard January to December timeframe. In contrast, a fiscal year is a 12-month period that you choose for your company. Canadian corporations have the flexibility to select any year-end date, which serves as the basis for determining various deadlines for the business. While personal and sole proprietor taxes align with the calendar year, staggered fiscal years for businesses can offer tax planning opportunities.

Starting a small business doesn’t have to be overwhelming, especially when it comes to accounting. Our team is here to help you with accounting, bookkeeping, and tax services to set you up for success. Feel free to contact us today to get started.