Last year in our
bookkeeping basics jargon article we covered some of the most common and important bookkeeping terms used in the accounting world. While these terms are well known to most people, as a business owner it is crucial to be aware of some of the basic accounting principles associated with them, that ultimately govern your business. Even if you have a bookkeeper to handle the financial aspects of the business, you might not always clearly understand them as numbers and accounting terms can be confusing.
Familiarising yourself with basic bookkeeping jargon and rules will help you understand and pick up on accounting and finance trends better thereby, helping you understand the figures of your business in more depth.
Here is a refresher of some of your most important bookkeeping phrases to keep you up to speed with the industry speak.
(GAAP vs IFRS) What’s My Accountant Talking About?
Particularly if you conduct business internationally, you should understand the differences between, and principles behind Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
More than 100 countries worldwide (including Australia) have adopted the IFRS model which aims to establish a common global accounting language. While standard across the EU, Asia and South America, the US has remained regulated under GAAP.
Here’s a simple video to explain it further:
What’s the difference?
The key difference between the systems as understood by many accountants is that GAAP is a rules-based methodology and IFRS is based more on principles.
While they’re not too different across countries, you should be aware of the reporting requirements.
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IFRS
Doesn’t require a statement of comprehensive income
Balance sheet requires separation of current and noncurrent assets and liabilities
Deferred taxes are shown as separate items on balance sheets
Minority interests (ownership positions by non-majority investors) included in equity as a separate item
Extraordinary items (eg. significant yet infrequent and unusual expenses) - are prohibited
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GAAP
Does require a statement of comprehensive income
Recommends separation of current and noncurrent assets and liabilities on balance sheets
Deferred taxes are included with assets and liabilities
Bank overdrafts are charged as a financing activity
Minority interests included in liabilities as a separate line item
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Profit And Revenue… Do They Mean The Same Thing?
This is something that can be easily confused. While profit and revenue are terms used interchangeably at times, there are differences when it comes to your cash flow forecasting.
Revenue
Is your sales. The total income dollar amount you receive when people purchase your goods or services. You do not subtract expenses to calculate your revenue. Revenue can also include monies collected via selling business assets.
Profit
There are two types of profit. Gross and Net. Calculating profits helps you compare previous profits from past accounting periods to determine your growth...or perhaps lack thereof.
Gross profit is calculated by subtracting your
COGS (Cost of Goods Sold) from your revenue. This is the purchase costs spent directly on buying or making your sold products, like materials for production. Shipping and warehouse costs, business admin and staffing costs are not included in your gross profit calculation.
Net profit is your business’s profit figures after subtracting ALL operating, interest and tax expenses and your COG’s.
What Is An Acid Test?
An acid test measures a business’s ability to pay its short-term debts. It is calculated by dividing your current assets (not including stock or inventory) by your current liabilities. The reason stock and inventory is left out of the equation is that it’s typically hard to sell-off in the short term. Your acid test ‘quick’ assets should be able to be converted into cash within 90 days. Such assets include current accounts receivable, marketable securities, cash or cash equivalents and short-term investments.
What Is Bad Debt
Bad debt is when accounts are owing to you but you are unlikely to receive. Whenever you extend credit to a customer in business, you risk it becoming bad debt if they fail to pay the outstanding balance. According to the Institute of Certified Bookkeepers, research shows that nearly one in two Australian businesses are vulnerable to bad debts by not performing credit checks on their customers.
To claim or write off bad debts on your tax return the debt must be irretrievable and not merely ‘doubtful’ that you won’t receive payment. Bad debt has to be written off in the year of income before a bad debt deduction is allowable.
Cash Flow Statement Explained
Your Cash Flow Statement (CFS) provides a summary of the amounts of cash and cash equivalents that enter and exit your company accounts. This report is a measure of how well you manage your cash position eg. how efficiently you generate cash to fund your business operating expenses and pay debt obligations. Your CFS is a mandatory element of your financial report and accompanies your balance sheet and income statement and enables investors to understand where the money is coming in, and how it is being spent in order to determine how well the company is running.
Your CFS is a valuable measure of profitability and the future outlook of your company.
If you’d like to learn more, here’s a simple video on
Types Of Business Expenses
There are essentially four types of business expenses:
1. Operational Expenses: The costs necessary for you to conduct your business. These expenses include items such as legal fees, insurance, repairs, depreciation and software subscriptions for example.
2. Fixed Expenses: These are your non-variable expenses that don’t alter in line with changes within your operation. Fixed expenses include mortgage or rent, utility bills and salaries.
3. Variable Expenses: Variable expenses are costs that do vary according to your business operations. For example inventory, sales commissions, packaging and freight costs will all rise in line with an increase in sales.
4. Accrued Expenses: Accrued expenses are single expenses or costs that have not yet been actually paid, but are required to be reported for accounting purposes. An accrued expense might be salaries that are payable due to wages earned by employees in one accounting period that are not payable until the next accounting period.
What is a Fiscal Year?
A company’s fiscal year is any 12-month period the company uses for accounting purposes - its financial year. Internationally a fiscal year can be the end of any quarter. In Australia, our fiscal year or financial year ends on the 30th June and begins 1st July.
What is Forecasting in Accounting?
Forecasting is a bookkeeping and accounting technique used to predict and determine the direction of future trends of a business. Used for business strategy and planning, forecasting uses historical data to make informed future estimates. A business will commonly use forecasting to help define their budgets and plan for future costs and expenses.
Xero and Accounting Jargon
Interestingly last year
Xero rolled out new intuitive navigation which included ditching accounting jargon. In their own words, they’ve replaced accounting terms with more ‘human’ wording in a bid to make the software easier to navigate and ‘simpler’ to complete tasks.
This might make the accounting system a little more user-friendly for business owners; but as long as there is taxation in this world, there will be accountants, and as long as there are accountants...there will be accounting jargon.
At Shoebox our professional bookkeepers work very closely with our business owners to help you keep on top of your books without the overwhelm. If you’re feeling confused by accounting jargon or bookkeeping software, get in touch for a software health check, training or assistance setting up your books, or our full bookkeeping services. We want to help you get back to working IN your business doing what you do best, not having a hard time working on your books.