Glossary of Accounting Terms
Running a business can be challenging enough, without having to also learn what feels like a whole new language. Don’t know your assets from your equity? This list is just what you’re looking for.
When your bookkeeper or accountant is preparing your accounts, they’ll do so for a particular period, normally a year but can also be a month or a quarter.
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 in your accounts as an accrual.
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 physically enters or leaves your bank account. So if your accounting period ends 31st March, and you issue an invoice to a client for £10,000 on 29th March, you would include that amount in March, even if you don't receive the money until 7th April.
Expenses that you can claim against your tax payment, such as stationery used in your business. It can be quite tricky to determine whether something can be allowed or not, so a lot of care needs to be taken when preparing your tax return.
Everything owner by a company, such as cash, buildings, tools, furniture, computers.
Balance sheet, or statement of financial position
As the name suggests, this balances the things owned by the business (assets) against everything invested in (equity) and owed by the business (liabilities). This forms part of your accounts, and presents a snapshot at a particular date in time.
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 (known as variances) which, depending on the size, may need to be investigated to understand what caused them and how they can be avoided in future.
Money provided to the business, normally by owners or shareholders.
You might expect that this refers to spending 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.
Some sole traders and partnerships can use cash accounting rather than the accruals basis. So instead of counting income and expenses when they're incurred, they're counted when the money actually enters or leaves your account. This means that you're only paying tax on money that you've actually received.
Money 'flowing' in and out of the business, and much more important than profit in my opinion, so you need to keep a close eye on it. It's perfectly possible to be profitable, but to go out of business because there's no cash.
Cost of goods sold/cost of sales
All costs associated with purchasing or making the products and services a business intends to sell to customers, for example silver for a jewellery maker.
This is someone you owe money to, and you might also see them referred to as payables (their opposite number is a debtor.)
Something that is expected to turn into cash relatively quickly, for example cash (obviously!) and payments due by customers.
Similar to current assets, these are expected to be settled within 12 months, so would include payments due to suppliers.
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.
Following the accruals basis, income needs to be accounted 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 'deferred' in your accounts to the period in which it is earned.
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.
Any expenses that relate directly to a unit of production, such as the cost of tyres if you're building cars.
Money paid to shareholders out of a company's profits (after corporation tax has been deducted.) If you're the 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, rather than dividends.
To paraphrase Newton's Third Law, everything in bookkeeping has an opposite and equal entry. So buying a pen reduces the balance in the bank account, and increases the amount spent on stationery.
Money taken out a business by a sole trader or partner. Unlike dividends, they're not limited to the profit made by the business - but take care to make sure you're not negatively affecting cash flow.
All of the money invested in the company by its owners, this may be made up of capital or shares.
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.
Refers to anything that is before any deductions (or after any additions, in the case of VAT.)
This is your profit after deducting, from your sales, the cost of goods/cost of sales, but before deducting other costs, such as administration or selling expenses.
Unlike direct costs, these are costs that aren't traced directly to a unit of production (whether that's a service or a physical good), but are still used in the running of the business. Expenses such as office furniture, telephone calls, and other administrative costs fall into this category.
These are all of the things that the company owes, so this group might be made up of things like loans and unpaid supplier bills.
Something is considered to be material if its omission or misstatement could influence decisions being based on the accounts. So if a small business bought something for £1 and recorded it incorrectly it would not be material, but if it had cost £1,000 it could be.
Refers to anything that is after any deductions (or before additions, in the case of VAT.)
Net book value
Anything that you depreciate will have a net book value. It is the original cost of the item, minus the depreciation that has accumulated over the years. Generally speaking, the value of the object when you dispose of it will be roughly the same as the net book value.
This is the number that people are normally the most interested in, and is the amount left after deducting all costs from your income.
An asset that is expected to remain in the business for more than 12 months, for example a chair, and so the cost is depreciated over several years. There is often a lower limit on the cost of an asset, say £500, for it to be considered a non-current asset.
Any regular expenses that you incur in order to keep the business running, so could include rent, phones, salaries, etc.
Payment on account
If you complete a self assessment tax return you may be required to make payments on account, this effectively means that you prepay the same amount of tax as the previous year towards the next year (paid in two equal installments in January and July). Any balancing payment is then due by 31st January of the following year.
These are expenses that have been paid for, but the benefit has not yet been received. For example in most cases you'll pay rent or insurance premiums in advance.
Profit and loss, or income statement
Provides a summary of activity over a period of time (normally a month, quarter, or year) and looks at the difference between income and expenses; if the figure is positive you've made a profit, if it's negative you've made a loss.
Provision for doubtful debts
This will be a deduction on your balance sheet and is an estimate of the payments you may not receive from customers, i.e. it is doubtful that you'll receive the money. This may be based on industry norms, or historical analysis of the business itself.
All of the sales you make, whether goods or services.
Self assessment tax return
How you report your tax liability to HMRC as a sole trader, part of partnership, or director of a limited company.
Expense directly affected by any changes in output, for example wood required to make chairs.