A glossary of common accounting terms
Navigating the world of accounting can be tricky with all of its different terms and phrases. This glossary will break down common accounting terms into simple, easy to understand explanations regardless of your knowledge level.
Assets
Assets are defined as “a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.” In other words, assets are valuable because they can generate revenue or be converted into cash. They come in two primary forms:
Tangible Assets: Physical items, such as machinery, buildings or inventory. These are easily quantifiable and play an important role in the production and operational processes of a business.
Intangible Assets: Non-physical resources like intellectual property (patents, trademarks), goodwill or brand recognition. These assets, while not tangible, can significantly increase a company’s revenue potential and market position.
Assets are reported on a company’s balance sheet, one of its key financial statements. They are categorised into current and non-current assets, reflecting their liquidity and how soon they can be converted into cash. Understanding and managing assets is vital for a business’s financial health and long-term success.
Accruals
Accruals ensure revenues and expenses are recognised when they occur, not when cash is exchanged. This gives a true picture of a company’s finances.
For example, if a service is performed but not paid for, accruals record the revenue immediately. This keeps financial statements accurate.
Common accrual accounts include:
- Accounts payable: Money owed to suppliers.
- Accounts receivable: Money customers owe.
- Accrued tax liabilities: Taxes owed but unpaid.
- Accrued interest: Interest earned or payable but not yet settled.
Accruals maintain the accuracy and transparency of financial statements.
Balance sheet
The balance sheet is one of the three main financial statements, showing a snippet of a company’s financial position at a particular moment. It lists total assets, liabilities and shareholders’ equity, highlighting how assets are financed through debt or equity. Based on the equation Assets = Liabilities + Equity, the balance sheet, also known as a statement of financial position, helps in financial analysis, modelling and strategic planning by reflecting the company’s liquidity and financial health.
Cash flow
Cash flow is important for a business to make timely payments to suppliers, employees, lenders and owners. It’s not just about having money but having it when you need it. Even a profitable business can run into trouble if big expenses come at the wrong time.
For small businesses, cash flow issues can prevent regular payments to owners, which can affect their personal finances too. Managing cash flow well is essential to keep things running smoothly.
Double-entry accounting
Double entry accounting is a core principle in finance. This system records every transaction in at least two accounts, ensuring all debits on the left match all credits on the right. When these sums agree, the transaction is balanced and suitable for financial statements; if not, corrections are needed. This method is essential for reflecting a business’s assets, liabilities and equity on the balance sheet. Without it, only an income statement can be produced, making it challenging to determine the overall financial position of the business. Double entry accounting is crucial for providing a complete and accurate picture of a company’s financial health.
General ledger
In the world of accounting, a General Ledger (GL) stands as the comprehensive record of a company’s past transactions, organised by accounts. These GL accounts capture every debit and credit transaction, alongside details such as dates, descriptions, amounts and often even the nature of the transactions. Within accounting software, the general ledger serves as the sorting hub for all transaction data, ensuring that every financial event finds its rightful place within the accounts. It’s the cornerstone for generating the company’s trial balance and financial statements, playing a key role in maintaining financial accuracy. The ledger’s precision is confirmed by a trial balance, which verifies that the total of all debit accounts matches the total of all credit accounts, upholding the integrity of the financial records.
Liquidity
Liquidity is an essential concept in accounting, denoting how quickly an asset can be turned into cash without losing its value. It reflects the ability of debtors to promptly meet their obligations. Assets with high liquidity can be easily sold at a fair market price, with cash being the most liquid asset. Equally, assets like real estate or land, which can take substantial time to sell, are considered less liquid. Understanding this distinction is beneficial for effective financial planning and decision-making, as it directly influences financial strategies.