Do you know your accruals from your prepayments, or your assets from your liabilities? If you think that I’ve just dipped into a foreign language, then this short glossary of bookkeeping terms is for you. Running a business can be challenging enough, without having to also learn what feels like a whole new language. There’s a lot to cover, so we’ll look at A-H in this post, and I-Z in a future one.
Accounting period When your bookkeeper or accountant is preparing your accounts, they’ll do so for a particular period, for most smaller businesses this is a year.
Accruals These are expenses that have been incurred, but not yet paid for. For example, in most cases you use electricity before you actually pay for what you’ve used, this would be recorded as an accrual.
Accruals basis This is the traditional way of preparing accounts, where income and expenses are included in the particular accounting period in which they occur, not when the money actually enters or leaves your bank account. So if your accounting period is a year, ending 31st March, and you issue an invoice to a client for £10,000 on 29th March you would include that amount in your accounts for that year, even if you don’t receive the money until 7th April.
Allowable expenses Expenses incurred that can be claimed against your tax payment, such as stationery used in your business. This can be a bit tricky, so if you’re not sure what you can claim, get in touch.
Assets Everything owned by a company, such as cash, buildings, tools, furniture, computers.
Balance sheet, or statement of financial position As the name suggests, it balances the things owned by the company (its assets) against everything invested in (equity) and owed by (liabilities) the company. This forms part of your accounts, and presents a snapshot at a particular date in time.
Budget At its most basic, this is simply a plan for how much money you expect to come into the business, and how it will be spent. Comparing this plan against the actual figures will likely result in differences (or variances) which, depending on the size, may need to be investigated to understand what caused them and how they can be avoided in future.
Capital Money provided to the business, normally by owners or shareholders.
Capital expenditure You might expect that this refers to spending the money provided by owners and shareholders, given its name, but it actually covers the purchase of non-current/fixed assets, such as machinery or computers.
Cash basis If you’re a sole trader or in a partnership, you’ll have seen this as an option when completing your self assessment tax return. Instead of counting income and expenses when they’re incurred, they’re counted when the money actually enters or leaves your account. So an invoice issued in March and paid in April would be counted in April. This means that you’re only paying tax on money you’ve actually received.
Cash flow Money ‘flowing’ in and out of the business, and much more important than profit in my opinion. It’s perfectly possible to be profitable and go out of business because there’s no cash, so you need to keep a close eye on this (not sure how to do this? I’ve got the perfect post for you.)
Cost of goods sold/cost of sales All costs associated with purchasing or making the products and services a customer intends to sell to customers, for example silver for a jewellery maker.
Creditor This is someone you owe money to, and you might also see them referred to as payables (their opposite number is debtor.)
Current asset Something that is expected to turn into cash relatively quickly, for example cash (obviously!) and payments due by customers.
Current liability Similar to current assets, these are expected to be settled within 12 months, so would include payments due to suppliers.
Debtor Someone who owes you money, so if you invoice your customers (thereby granting them ‘credit’) then they are your debtors until payment is received. You might also see them referred to as receivables, and their opposite number is a creditor.
Depreciation This effectively spreads the cost of certain assets across their expected life, so if you buy a computer that you expect to have for 3 years you would show a portion of the cost in the accounts across each of the 3 years.
Deferred income Following the accruals basis, income needs to be counted in the period in which it’s earned, not when the cash is received. This means that if a client pays you in one accounting period for work that you will do in the next period, this needs to be shown in your accounts as deferred income, as you have not yet earned this.
Direct costs Any expenses that relate directly to a unit of production, such as the cost of tyres if you’re building cars.
Dividends Money paid to shareholders out of a company’s profits (after corporation tax has been deducted.) If you are a director of a limited company, this is probably the main way in which you receive money from the company. Sole traders and those in partnerships receive money in the form of drawings.
Double-entry bookkeeping To paraphrase Newton’s Third Law, everything in bookkeeping has an opposite and equal entry, which underpins everything. So buying a pen reduces the balance in the bank account and increases the amount of money spent on stationery (which, if you’re anything like this stationery-loving ninja, is a common occurrence!)
Drawings Any money taken out of a business by a sole trader or partner. Unlike dividends (paid to directors of limited companies), they’re not limited to the profit made by the business - but take care to make sure you’re not negatively affecting cash flow!
Equity All the money invested in the company by its owners is known as equity, which may be made of capital or shares.
Fixed cost An expense that is not affected by any changes in output, for example you will pay the same rent on your factory whether you make 1 widget or 1,000 (until you run out of room and have to rent a bigger factory, but let’s keep it simple!) Costs that go up or down in line with output, such as fabric for clothes, are classed as variable.
Gross Refers to anything that is before any deductions (or after any additions, in the case of VAT.)
Gross profit This is your profit after deducting, from your income, the cost of goods sold/cost of sales, but before deducting other costs, such as administration and selling expenses.
I hope that this glossary things a little clearer for you when you’re dealing with your accounts or talking with your bookkeeper/accountant. Don’t forget to come back to see what I-Z has in store!