Small Business Accounting: Terms You Should Understand

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.

Hiring an accountant will relieve you of the worry of accurate bookkeeping, payroll, and taxes, allowing you to focus on other more important things. Delegating financial obligations, however, does not imply that you should abandon the process and pay it no more mind. Working closely with your accountant during the year will give you a greater understanding of your financial situation, allowing you to better plan for the future of your business.

Understanding some basic accounting terms is the first step toward improving your accounting knowledge and your business’ financial well-being. As a business owner, you should be familiar with the following accounting terms and their basic meaning:

Cash Flow

The quantity of money flowing in and out of your organization is referred to as cash flow. You are “cash flow positive” if you have more cash flowing into your business each month than you pay out to meet bills and expenses.

The ability of a corporation to generate positive cash flow aids potential investors in determining the health of the organization. You’ll be better able to keep up with debt, pay unexpected expenses, and engage in development possibilities if you have extra cash on hand. If the contrary is true (and money is flowing out of your firm faster than it is coming in), your cash flow statement will show that you’re “cash flow negative.”

If keeping track of cash flow is a top priority for you, ask your accountant if they can prepare a cash flow statement for you every quarter (or month, or week) so you can stay on top of it.

Profit and Loss Statements

One of the most essential documents used by accountants to determine the profitability of your firm is the profit and loss statement (also known as the income statement or P&L statement). It explains how a company’s net income is calculated, making it a useful indicator of your company’s management and operations.

Revenues and gains, as well as expenses and losses, are listed on the P&L statement for a certain time period (annually, quarterly or monthly). It estimates your “bottom line” so you can see if you’re losing money or making money at a glance.

EBITDA

The profit and loss statement aids in calculating net business profit. The EBITDA measure is another frequent indicator used to evaluate firms (and stands for earnings before interest, taxes, depreciation and amortization).

Start with your net income and multiply it by your interest expense, tax expense, and depreciation expense to get your EBITA. This gives you a more objective, clear view of how much money your company produced before you spent it on non-operating products (items that aren’t necessary to run your firm).

EBITDA allows you to compare businesses in the same industry on an apples-to-apples basis. It’s more objective since it excludes factors that are based on subjective management decisions but have the potential to affect net income. These are some of them:

• Indebtedness (or leverage)
• Various tax brackets (may be location or business-structure dependent)
• Capital expenditures that are subject to depreciation.

This is a non-cash figure, and the true cost would be the capital expenditures required to keep the business running. These can vary significantly from business to business, even if they operate in the same niche.

For example, some businesses prefer to lease equipment or cars rather than purchase them permanently. Others may spend more on upkeep and use their equipment for longer periods of time, rather than trading up every few years to get the most up-to-date equipment.

Balance Sheet

The balance sheet depicts your overall financial situation at a specific point in time. It tracks a company’s assets (cash, inventory, accounts receivable, and equipment), obligations (such as accounts payable, income taxes, and employee salaries), and shareholders’ equity. The balance sheet, in a nutshell, illustrates what you own as well as what you owe.

Accounts Payable and Accounts Receivable

Accounts payable are bills and invoices that you need to pay for business expenses that haven’t been paid by the end of the period. It’s money you owe suppliers as well as any invoices you haven’t paid yet. Until the bills are paid, it’s represented as a liability on your balance sheet.

Accounts receivable, on the other hand, is money due to you by your clients but not yet paid. Even though the revenue has yet to be collected, it is recorded as an asset on your balance sheet.

However, bad debt should be treated carefully. When you are unable to collect payment from your customers, it’s a bad debt. On your balance sheet, outstanding accounts receivable are represented as an asset, but they must be written off as a bad debt expense as soon as you know you won’t be able to collect. This depreciates the asset and increases the expense on your balance sheet.

Trial Balance and General Ledger

The trial balance is a list of all the accounts that make up your balance sheet and income statement (profit and loss statement). This shows the final balance of each of these accounts at a certain point in time, which is usually your year’s conclusion.

The general ledger has the same accounts as the ledger book, but it will show all of the data for each individual transaction that passed through each account, including the date it occurred.

Consider the trial balance to be your “bank balance,” and the general ledger to be your “bank activity.”

Operating Versus Capital Expenses

The items you spend money on to manage your firm are known as operating expenses. Cost of goods sold, administrative expenses, and research and development are all examples of this. Items that are used for one year or less and cost less than $1,000 are considered operating expenses. These would appear on your income statement as expenses.

On the balance sheet of the business, capital expenses are reported as assets. They’re usually kept for longer than a year. Capital assets are depreciated during their useful lives, with a recurring depreciation expense (which appears on the income statement). Computers, furniture, and automobiles are all examples. Typically, capital expenses are $1,000 or more.

Here’s a common example to illustrate the difference between the two. Purchasing a vehicle is a capital investment because you will own it and be able to use it for many years. Because you’re paying a monthly fee for the use of the car, but your company doesn’t own it, leasing a vehicle is an operating expense.

Fiscal Versus Calendar Year

A calendar period is the year that ends on December 31st, the calendar that we all use throughout the year.

A fiscal period is the 12-month period that you choose for your company. Any year-end can be chosen by a Canadian corporation, and this date will serve as the foundation for determining when various deadlines for your firm will occur.

A company with a fiscal year-end of September 30 would have an operating year from October 1, 20XX to September 30, 20XX. Personal and sole proprietor taxes are always accounted for in a calendar year, and staggered fiscal years for businesses can provide some interesting tax planning opportunities.

Small business accounting doesn’t have to be overwhelming; our team is here to help provide accounting, bookkeeping and tax services, and set you up for small business success. Contact us today to get started.