I took a lot of Spanish through school, about 8 years in total. Since that time, I’ve lost almost all of it due to lack of use, but the things I do remember are the vocabulary words. I don’t think I could form a complete sentence or conjugate a verb to save my life, but I absolutely remember the Spanish word for hand (it’s mano!).
The basis of any language is its vocabulary words – and even though I am far from fluent – I’m pretty sure I could get by in any Spanish speaking country armed solely with the handful of vocabulary words I still know.
The vernacular of skilled trades and specialized professions has the same effect as foreign languages. By understanding a handful of key fundamental words and terms, “laypeople” become able to grasp the concepts of the respective skill or profession. They may not be able to actually perform any of the job functions, but they can certainly understand and engage in a conversation with a certified specialist and follow what is being shared.
As you may be gathering from the previous articles on this topic, this is especially true with Accounting and Bookkeeping. So, you’re new to the bookkeeping requirements inherent in successfully running your business, learning some of the most common words, phrases, and concepts is a good way to begin your education.
Here are 3 more bookkeeping and accounting terms you should know.
Cost of Goods Sold
Your cost of goods sold (COGS) is exactly what it sounds like. The cost incurred by creating the product or service that you sell.
What constitutes your COGS varies pretty wildly from one industry to the next. It just depends on the product you’re selling. A manufacturer might include their raw materials and packaging. A website designer might have client software subscriptions or site hosting fees.
Your COGS will depend entirely on what type of product you’re selling, but almost all businesses will have some form of COGS.
The COGS is essentially just an expense, but it’s an extremely vital expense to track. It allows you to keep a close eye on profitability. If your income is consistently lower than your COGS, then it’s time for you to review your costs and profits to ensure your sale price is right for your business.
Accounts Payable (A/P)
Accounts payable refers to the money that you owe to the outside world. Normally this will be for something that you’ve already received. Otherwise known as a liability.
For example, a contractor might buy materials on account or with terms. This means that he or she receives the materials needed for a job, but payment is not required at the time of pick-up or delivery because some type of extended payment terms have been arranged.
Your accounts payable represent money you owe to someone and must be accurately tracked within your bookkeeping software. Without this liability in your books, it looks like you received the materials or service for free. This will inflate your assets and over-value your business, which could cause you to pay excess taxes.
Accounts Receivable (A/R)
Accounts receivable represent the money that is owed to you/your business; most often from customers.
Accounts receivable are the flipside to accounts payable. An open “accounts receivable” in your books will be an open “accounts payable” in your customer’s books.
There is always a certain level of risk with accounts receivable. You’re providing your service or product on the assumption that you’ll get paid at a later, predetermined date.
Unfortunately, it doesn’t always work out this way. Allowance for bad accounts are the A/R that you have on your books that you finally realize won’t ever be paid.
Tracking your accounts receivable needs to involve tracking when each customer has paid in the past, and how often invoices go past their due date without being paid.
Prepaid Expenses
A prepaid expense is an expense that you pre-pay. Surprise! Bet you saw that coming.
This only applies when your books are in the accrual basis (link). If you’re on the cash basis, then this doesn’t apply to you.
If your books are in the accrual basis, then it’s important to know that a prepaid expense is actually an asset until you “use” it. Now, I say “use” because it may be only in the theoretical sense. Let me explain.
The most common example of a prepaid expense is insurance. If you pay your insurance in a lump sum every year or 6 months, then it is considered a prepaid expense. The reason for this is because you’ve paid for 6 months of insurance, but you’re only going to record it as an expense once the time has passed.
If you pay $600 for 6 months of insurance, it should be expensed as $100 a month, as you “use” it. Whether or not you file a claim is irrelevant. It’s only the passing of the time that really matters in this scenario.
Just remember that the insurance is for 6 months, so you need to proportion the lump payment on a monthly basis over 6 months. (In this example, $600 over 6 months means $100 per month for 6 months.)
If your books don’t reflect the lump payment as monthly installment payments, your expenses are going to be overstated that first month when you pay the total and understated for the next 5 months when you make no payments.
Bottom Line:
The most effective way to retain any realm of knowledge is to use it and apply it. Acquiring and applying bookkeeping knowledge is not only beneficial to you as a business owner, it also gives your business a competitive edge.
Learning the meanings and applications of basic accounting and bookkeeping terms accelerates every aspect of your business knowledge and acumen. This does not mean memorizing the definitions of the terms and phrases presented in this blog series. It means actually understanding their meanings to such an extent that the words become part of your everyday business vocabulary and mindset.