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 third in an ongoing series designed to provide small business owners with a clear understanding of essential accounting terminology. To read prior articles in the series, please visit:
- Understanding Small Business Accounting Terminology – Part 1 (A through C)
- Understanding Small Business Accounting Terminology – Part 2 (D through F)
- Understanding Small Business Accounting Terminology – Part 3 (G through I)
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, covering those that begin with the letters J through M:
- Journal Entry – A notation or record added to the general journal for a company’s accounting system, which will include the date, the amount and account(s) to be debited and/or credited, a description and a reference (such as a check or transaction number). Journal entries are then posted to the general ledger.
- Key Person Insurance – A life insurance contract, owned by the business, that provides coverage on the lives of principal officers/executives to provide guaranteed benefits to the company in the event of a covered individual’s death.
- Last In First Out (LIFO) – An accounting method of valuing physical inventory in which the costs of the most recently acquired goods are the first costs charged to expenses. This is in contrast to First In First Out (FIFO), where the costs of goods are charged to expenses in the order in which they were originally purchased. The decision between FIFO and LIFO methods may be particularly relevant in cases where the acquisition cost of the same good fluctuates significantly over time.
- Ledger – A book of accounts containing the summaries of both debit and credit entries.
- Letter of Credit – A letter issued by a bank that provides a conditional bank commitment on behalf of a customer or a third party, based upon previously defined conditions.
- Liabilities – Debts or other obligations owed by one entity (the debtor) to another entity (the creditor). Liabilities are payable in money, goods or services.
- Limited Liability Company (LLC) – A business entity format that combines the advantages of limited liability (where the owners are liable only for their investments in the business and not for the entity’s own debts), with the taxation benefit of a partnership (where the owners are called members). LLCs are regulated differently in each state, and LLCs commonly file taxes with the IRS under “S Election”, which means that they are taxed at the federal level as an “S” corp.
- Liquidity – The total of available funds on hand to pay bills when they are due and to address any other unanticipated cash requirements. Often measured using the liquidity ratio, which measures the firm’s ability to meet all of its short-term obligations as they mature.
- Loan-to-Value (LTV) – A ratio used by lenders (banks and other financial institutions) to represent the ratio of a loan amount to the assessed value of the asset being financed with the loan. Commonly used in real estate lending, LTV is a key risk factor that is assessed by lenders.
- Loss – The difference between expenditures versus revenues in an entity over a defined period, where the expenditures exceed revenues during the period. For tax purposes, a loss is defined as an excess of basis over the amount realized in a transaction.
- Management Accounting (or Managerial Accounting) – Accounting reports and analytical tools designed specifically to assist management personnel in their ability to plan, control, and make decisions about the business. This is in contrast to public accounting, which is primarily concerned with the accuracy and compliance of a company’s public accounting statements, or financial accounting, which focuses more narrowly on a company’s financial transactions and reports.
- Margin – The amount in excess between a selling price and the cost of a unit of goods sold. Examined broadly, the margin of profit is defined as the relationship of gross profits to net sales.
- Marginal Tax Rate – The value or amount of taxes paid on a given additional dollar of income where a progressive tax is applied. If the tax is A percent for income generated between X and Y, and the rate moves to B percent for income generated between Y and Z, then the marginal tax rate for the amount between Y and Z is B minus A.
- Market Capitalization – The value of a business entity (corporation) as determined by the market price of its issued and outstanding common stock. In addition, startup companies are often assigned an estimated market capitalization based upon the value of the investments made in the business up to that point.
- Markup – The amount added to the price of a product by the retailer or distributor that establishes the selling price. Put another way, it is the difference between the retailer’s or distributor’s purchase price and selling price.
- Merchandise Inventory – The total of all goods (products) currently in the possession of a business, which can in turn be sold to customers.
- Matching Principle – A core concept in accounting that establishes the importance of ensuring alignment between revenues and expenses in a given period. The principle states that a business should match the revenue it reports against the expenses it incurred to generate that revenue.
- Merchandise – Products (items, goods) that can be purchased or sold by the business.
- Moving Average Inventory Method – A method of inventory costing used to determine the average cost of perpetual inventory. Under this approach, the average cost of each individual inventory item in stock is re-calculated after every inventory purchase. This approach provides a solution in between the FIFO and LIFO methods, but only works in cases where a perpetual inventory system is in use (and is not applicable where a periodic inventory system is applied). Today, most inventory systems are perpetual since technology can be used to record inventory transactions (purchase or sale) instantly using applicable software.
- Mutual Agency – The right of all partners or owners/members of a corporation to represent the entity and bind it to contracts. This ‘agency’ or authority is generally given to owners and select executives of the company on its behalf.
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!