Accounting Terms for Small-Business Owners

These definitions are general information, written for people who keep the books without an accounting background. Terms can carry slightly different meanings between software products, and tax treatment varies by place, so your CPA has the final word when a definition matters to a decision. For the steps where these terms come up, see the month-end close checklist.

Accounts payable

Money the business owes to suppliers and vendors for goods or services it has received but not yet paid for. Usually abbreviated AP.

Accounts receivable

Money customers owe the business for work done or goods delivered but not yet paid. Usually abbreviated AR. An aging report shows how long each amount has been outstanding.

Accrual accounting

A method that records income when it is earned and expenses when they are incurred, whether or not cash has moved. Compare it with cash basis.

Accrued expense

A cost the business has incurred but not yet been billed for or paid, such as the last week of utilities at month end. It is recorded as an expense and as a liability.

Aging report

A list of unpaid invoices or bills grouped by how overdue they are, for example current, 30 days late, 60 days late. It shows which customers to chase and which bills to pay first.

Amortization

Spreading the cost of an intangible asset, or a loan balance, over a set period. For an asset, it works like depreciation does for equipment.

Asset

Something the business owns or is owed that has value: cash, receivables, inventory, equipment. Assets sit on the balance sheet.

Balance sheet

A statement of what the business owns, what it owes and what is left for the owner, as of a particular date. Assets equal liabilities plus equity.

Bank reconciliation

Matching the balance in your books to the balance on the bank statement, and explaining every difference. Timing differences such as uncleared checks are normal; unexplained ones are not. It is done for each bank and card account at least monthly.

Bookkeeping

Recording and organizing the business’s financial transactions so the books are accurate and current. Accounting builds on those records to analyze, advise and report.

Cash basis

A method that records income when cash is received and expenses when cash is paid. It is simpler than accrual accounting, but which method a business may or must use depends on rules that vary by place and size, so check with your CPA.

Cash flow

The movement of money into and out of the business over a period. Profit and cash flow can differ a lot, because unpaid invoices and bills, inventory purchases and loan payments affect one and not the other.

Chart of accounts

The list of all the accounts that transactions can be recorded in, grouped as assets, liabilities, equity, revenue and expenses. See how to set one up.

Closing the books

Finishing the accounting for a period, such as a month or a year, so that the figures are final and further changes are controlled. It involves reconciliations, adjustments and a review.

Cost of goods sold

The direct cost of producing or buying what you sold during the period, such as materials and product costs. Abbreviated COGS. Subtracting it from revenue gives gross profit.

Credit

The right-hand side of a double-entry journal entry. A credit increases liability, equity and revenue accounts, and decreases asset and expense accounts. It does not mean “good” or “money in”.

Debit

The left-hand side of a double-entry journal entry. A debit increases asset and expense accounts, and decreases liability, equity and revenue accounts. It does not mean “bad” or “money out”.

Deferred revenue

Money received before the work is done or the goods are delivered. It is held as a liability until earned, then moved into revenue.

Depreciation

Spreading the cost of a physical asset, such as a vehicle or machine, over the years it is expected to be used, instead of recording the entire cost as an expense at purchase. Methods and schedules differ for books and for tax.

Double-entry bookkeeping

A system where every transaction is recorded twice, as a debit in one account and an equal credit in another. It keeps the books in balance and makes errors easier to find.

Equity

The owner’s stake in the business: what the owner has put in, plus profits kept in the business, minus what has been taken out. What equity looks like depends on the business structure.

Expense

A cost of running the business during a period, such as rent, wages, software or advertising. Expenses reduce net income.

Fiscal year

The twelve-month period a business uses for its annual accounts and, in many places, its taxes. It can follow the calendar year or end in another month.

General ledger

The master record of every account and every transaction posted to it. Reports such as the profit and loss and balance sheet are drawn from it.

Gross profit

Revenue minus cost of goods sold. It shows what is left from sales to pay for operating costs, before those costs are deducted.

Journal entry

A record of a transaction or an adjustment, showing the accounts it affects and the debits and credits. Adjustments at month end, such as accruals and depreciation, are usually made by journal entry.

Liability

An amount the business owes: loans, payables, credit cards, taxes collected but not yet paid. Liabilities sit on the balance sheet.

Net income

What remains after all expenses are subtracted from revenue for a period. A positive figure is a profit and a negative one is a loss. Also called net profit or the bottom line.

Owner’s draw

Money a sole proprietor or partner takes out of the business for personal use. It is recorded in an equity account, not as a business expense. How owners of corporations are paid is handled differently, so ask your CPA.

Prepaid expense

A cost paid before the period it covers, such as a year of insurance. It is an asset when paid and becomes an expense month by month.

Profit and loss statement

A report of revenue and expenses for a period, ending in net income. Also called an income statement. It shows performance across a span of time, where the balance sheet shows a single date.

Retained earnings

The profits a business has kept over time instead of paying out to its owners. It is part of equity.

Revenue

Money earned from the business’s main activity during a period. Also called sales or income. Revenue is not the same as cash received if customers have not yet paid.

Runway

The number of months the business can keep operating with its current cash, given its income and spending. See the cash runway calculator.

Trial balance

A list of every account with its debit or credit balance at a point in time. If the books are in balance, total debits equal total credits. It is a check, not proof that every entry is correct.

Undeposited funds

A holding account for customer payments recorded in the books but not yet deposited into the bank. It should be cleared when the deposit is made.

Working capital

Current assets minus current liabilities, which is a rough measure of short-term financial breathing room. What counts as current is defined in accounting standards, so ask your CPA if it matters for a loan or a contract.

Write-off

Removing an amount from the books because it will not be collected or no longer has value, such as a customer invoice that will not be paid. The treatment can matter for taxes, so ask your accountant first.