Bookkeepers and Accountants definitely have their own language. They throw terms around that make sense to them but go right over the heads of business owners without any education in the subjects. But that shouldn’t be acceptable.
Every business owner needs an understanding of fundamental accounting terms and concepts so that when meeting with their bookkeeper and accountant they can be part of the conversation.
In the first of this 3-part series, I’m going to define and explain the three common accounting and bookkeeping terms that you will need to know. These three terms are variables in what’s known as the accounting equation. – one of the most basic aspects of bookkeeping.
Assets = Liabilities + Equity
These three terms account for all of the transactions and data that make up your books; understanding what they mean is the first key to understanding your books.
These definitions have been simplified for this purpose. Look at this article as an introduction to these terms and concepts providing you with baseline knowledge that you can build upon as you develop your relationships with your CPA, bookkeeper, and – yes – even your business.
Assets
Assets are the things that the business owns; computers, machinery, equipment, inventory, and supplies are all examples of assets. Assets have value and add to the value of your business.
An asset is essentially anything that can be converted to cash. For example, this obviously includes the cash in your checking account but also includes things like accounts receivable.
Assets may depreciate in value. This means that their value goes down over time as they cease to be useful or needed. Good examples of these assets are equipment or vehicles. For example, when you buy a car, it’s expected to be worth less in five years than it was the day you bought it. That is depreciation of an asset.
Liability
Liabilities are what you owe to other people or businesses.
The most common liability is typically a trade of an asset for a liability. For example, you take out a loan for a car. You get the car (asset), but you still owe the money to the bank (liability). In your books, the two will balance out.
A liability that’s often overlooked by business owners are gift cards and gift certificates. Your customer gives you money (asset) that requires you to provide a service or good at a later date. Gift cards or certificates should not be recorded in your books as revenue until the gift card or certificate is redeemed for its respective service or good.
Equity
Equity is a little harder to define. It’s essentially the monetary value of the business beyond what it owes. This includes things like the business’ gross revenue or the business owner’s personal investment of money into the business. When the business owner invests money in the business, the business’ equity increases. And when the owner pulls money out, the equity decreases.
Equity is also referred to as “owner’s equity” or “shareholder’s equity”, depending on how the business entity is set up. These terms are interchangeable, but equity is often sufficient.
Bottom Line:
Accounting is an incredibly complex, head-spinning subject. This is true for those who have a basic understanding of it and especially true for those who don’t, as is the case with many entrepreneurs and small business people.
However, accounting principles and practices become less of a mystery when you recognize and understand the fundamental concepts and terms – starting with bookkeeping. This is how a productive, collaborative relationship with Still Waters Bookkeeping begins.
Still Waters Bookkeeping specializes in working with clients to educate and engage them in the aspects of bookkeeping that are most critical to their goals, profit, and success. We welcome the opportunity to show you how and why this level of engagement contributes to the overall health of your business and quality of your life.