As a CEO, you’re busy every day managing numerous tasks, challenges, opportunities and priorities. At the same time, you need to be conversant with the language of business, and that includes core accounting terms. In this article, we continue our ongoing series on the essential accounting terms that every small business owner needs to know.
Editor’s Note: This article is the second in an ongoing series designed to provide small business owners with a clear understanding of essential accounting terminology. To read the first article in the series, please visit:
It’s essential that small business owners know the language of accounting, since accounting is the language of business. With that in mind, here are essential terms worth exploring, beginning with the letters D through F:
- Debit – This is an accounting entry in which there is either an increase in assets or a decrease in liabilities on the company’s balance sheet.
- Depreciation – The decrease in an item’s value over time due to use. Also defined as the amount of an item’s value to the business, allocated or apportioned over a given segment of time. For example, if you purchase a business computer, it may have a useful life of five years. That means that the value of the device will be reduced every year as you ‘draw down’ its overall value over time. This term is particularly important for tax purposes, since depreciation on items over a multi-year period can provide businesses with the opportunity to lower tax burden.
- Dividends – Dividends are company earnings that are distributed on a consistent basis to its owners/shareholders. The amount of a dividend or its percentage may be decided by the board of directors of the entity in most cases. Dividends are one method for directing the use of profits generated by the business; another option is to re-invest those firms back in the company to drive or support future growth.
- Double-Entry Bookkeeping – The formal system of accounting in which every transaction has a corresponding positive and negative entry. These are referred to as debits and credits. This process ensures that the books are always ‘in balance’.
- Equity – Often misunderstood and misapplied, this term refers to the amount of money invested in the company by its owners. In a typical small business with a single owner, this is defined as Owner’s Equity and is shown in a capital account. In a larger business, it is shown in shares of stock. Owner’s (or shareholder’s) equity is calculated by taking the total assets of the company and subtracting the liabilities. This can also be referred to as net worth or book value.
- Expense (Fixed) – A fixed expense or cost is an expense that does not generally fluctuate over time with changes in your company’s volume of production or sales activity (at least until a certain threshold has been reached). Examples of common fixed expenses include rent, insurance, membership dues, subscriptions, equipment leases, loan payments, asset depreciation, salaries for management personnel, building maintenance costs, and the costs of marketing and sales campaigns.
- Expense (Variable) – A variable expense or cost is an expense that regularly fluctuates over time with changes in your company’s volume of production or sales activity. Examples of common variable expenses include any that are directly tied to changes in activity level, and may include raw materials, wages for hourly production and operations personnel, sales commissions, investors carrying costs, packaging supplies and shipping costs.
- Expense (Accrued) – An accrued expense is a single accounting expense that is being reported but has not yet been paid (disbursed).
- Expense (Operational) – An operational expense (or OpEx) is an expense (or cost) that is necessary in order for the company to conduct business in the first place. Put another way, operating expenses are those expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services.
- Financial Accounting – The area of accounting that is focused specifically on reporting a company’s activities to an external party. In public companies, for example, this is the process of reporting to shareholders.
- Fiscal Year – The fiscal year is the period of time that a business selects for use in preparing financial statements and reporting taxes, among other responsibilities. Many small businesses use the calendar year as their fiscal year (i.e. January 1st through December 31st). However, other common options include October 1st through September 30th, or July 1st through June 30th. These alternatives are often selected due to the complexity of a company’s end-of-year reporting requirements, or in alignment with other standards (such as public company reporting in the stock markets, or the federal fiscal year for government contractors).
- Fixed Asset – This refers to all long-term, tangible properties of the enterprise. Typically, fixed assets include land, buildings, manufacturing equipment, computers and office equipment.
- Forecasting – The process by which historical data is used to evaluate, define and predict future business growth trends and budgets. Typical components in forecasting include supply and demand expectations from the marketplace, coupled with sales history and current expenses.
Want to learn more about these terms, or explore additional terms relevant to your business? Stay tuned for future installments in this series. In the meantime, speak to your small business CPA today to learn how you can become more conversant – and confident – with essential accounting terms that are relevant to the growth of your business!