Glossary - Accounting
Accounts Payable - Accounting term for money which a business owes to a supplier of a product or service that the business has obtained on short-term credit. An accounts payable entry will normally be listed on a balance sheet under the heading of ‘current liabilities’. In larger organisations, ‘accounts payable’ may refer to an individual or department dedicated to handling the payment to suppliers and other creditors.
Accounts Receivable - Accounts Receivable is the accounting term for money owed to a business by customers who have been supplied with a product or service on short-term credit. An accounts receivable entry will normally be listed on a balance sheet under the heading of ‘current assets’. In larger organisations, ‘accounts receivable’ may refer to an individual or department dedicated to handling payments from customers and other debtors.
Accrual-based Accounting - Accrual-based accounting is an accounting method in which income and expenses are entered into the books of business at the time they are incurred, regardless of whether cash has changed hands of not. For example, a business which makes a credit sale will enter the transaction as a ‘sale’ at that point, rather than waiting until payment is actually received. Similarly, when the business receives goods or services on credit, these are immediately recorded as an expense, even though they may only be paid for at a later date.
Accumulated Depreciation - Accumulated Depreciation is the total amount by which an asset’s value has decreased over a specified period of time, possibly several years. Typically an asset will be shown on a company’s balance sheet as depreciating monthly or annually, and ‘accumulated depreciation’ is the total amount by which that asset has depreciated over, for example, three or four years. So the Book Value of the asset (ie: its current net worth) will be calculated by Cost of Asset less Accumulated Depreciation.
Acquisition Cost - The total cost to a business of acquiring a new customer. This may include marketing and advertising expenditure, discounts, special incentives and the costs incurred by salespeople visiting the customer. The customer acquisition cost is calculated by dividing Total Acquisition Costs by Total New Customers over a set time frame. ‘Acquisition cost’ may also refer to the cost of an asset after adjusting for discounts and other incidental costs.
Assets - Assets are an economic resource, owned by an individual or organisation, which can be converted into cash or has a potential cash value. The two main classes of an asset are ‘tangible’ or ‘intangible’. The former includes physical resources like stock, plant and equipment while the latter includes copyrights, patents and brands. In the accounting context, assets are either ‘current’ or ‘fixed’ The former includes cash, stock and accounts receivable (which are likely to be consumed within a year), while the latter includes buildings, property and equipment (which will provide ongoing benefits).
Audit - In general terms, an ‘audit’ may refer to any evaluation of a system, process, organisation, product or individual. However, the term is still most commonly used in accounting, where it is used as an unbiased check of the validity and reliability of a company’s financial statements. It is also commonly associated with the checks carried out by the South African Revenue Service to determine whether specific individuals or organisations are meeting their tax obligations.
Bad Debt - An accountancy term for accounts receivable that are unlikely to be paid and must, therefore, be ‘written off’ once all reasonable efforts to collect the debt have been made. Bad debt is regarded as in expense in the books of the business because it has involved the use of company assets for no gain. When preparing financial statements for a business, accountants will routinely make an allowance for anticipated bad debt, based on previous experience and norms.
Balance Sheet - A summary of the financial position of a business or other organisation on a specified date, typically the end of the financial or calendar year, and which is used to calculate the net worth of the business. Each balance sheet follows a formula: Assets = Liabilities + Shareholders’ Equity. It is referred to as a ‘balance sheet’ because it is necessary for the two sides (assets & liabilities) to balance out: total assets must equal liabilities plus equity (how the assets are financed).
Breakeven Analysis - A method of determining at what point a company’s financial situation is in equilibrium and it makes neither a profit or a loss. In doing a breakeven analysis, management will typically calculate the volume of sales and/or income required to cover the costs associated with producing it. If sales/income is predicted to fall below this point, then the operation is deemed unviable or in need of further action, for example reducing the unit cost of producing the item.
Budget - Accounting term for a financial document which projects future income and expenditure by an individual or organisation, in order to determine whether the individual/organisation can continue to operate in this manner. In simple terms, preparing a budget means listing all sources of income for a specified period (usually monthly or annually) and then comparing this to a list of fixed expenses (mortgage, rent, electricity, etc) and a list of other possible and variable expenses. A surplus budget means profits are expected, while a budget deficit indicates expenses will exceed revenues.
Business Expenses - The operating costs of a company which are regarded as ordinary and necessary for the running of the business. These will typically include phone calls, equipment purchases, travel expenses, etc. Whether a particular expense is ‘necessary’ or ‘ordinary’ in order to be tax-deductible for that particular business is one of the most difficult decisions that company accountants must make, as they are often open to interpretation and changing SARS regulations.
Business Income - Any income that is earned by a company in the normal course of its business activities. This may include revenue earned from the sale of products, from consulting fees, hire of items, etc. Business income can be offset against business expenses and business losses for the same specified timeframe, typically a calendar or financial year. Thus, business income can be either positive or negative.
Cash Flow - The movement of cash into and out of a business during the normal course of its operations and usually measured over a specified period of time A strong and positive cash flow is a healthy business indicator. Cash flow is determining by:
Cash income less cash payments (e.g. operating expenses, rent, etc.) for the specified period.
Cash Flow Analysis(Cash Flow Forecasting or Cash Flow Projection) - This analyses the cash inflows and outflows of the business to ensure that cash flow is managed effectively over a set period of time, typically a month. Elements which should be analysed as part of this process include accounts receivable, accounts payable, inventory and credit terms. Without proper cash flow analysis, a company may experience liquidity problems and could ultimately go out of business.
Cash Flow Budget - Similar to Cash Flow Analysis, it involves longer-term forecasting, typically a calendar year or financial year, and will be for budgeted rand amounts rather than actual rands flowing into and out of the business. It enables the organisation to plan ahead to maintain optimum cash flow and will show, for example, when additional funds will need to be borrowed or when debt repayments can be scheduled
Cash Flow Statement - A formal financial statement showing a summary of cash inflows and outflows as a result of operating, investment and financial activities over a specified period of time. It complements the Balance Sheet and Income Statement and allows the board and potential investors to understand the company’s liquidity, how it is obtaining its money and where it is being spent
Cash Sales - A business transaction for which payment is received immediately via cash, cheque, credit card or electronic fund transfer. It may also refer to a transaction on the stock exchange floor which requires delivery of the securities on the same day, as opposed to the stock exchange norm of delivering on the third day.
Collection Period - Also called the Average Collection Period, this is the average length of time that it takes a company’s credit customers to pay their debts. The lower the period, the better it is for the business, as it means that funds are more quickly available for operating expenses or to service its own debts. A long average collection period is a warning sign that the company may be extending credit to too many high-risk customers or that general economic conditions are worsening.
Current Debt - Also known as Current Liabilities. These are obligations which the business must meet within one year, or less, of the date of a financial statement. Current Debt will appear on the business balance sheet and includes accounts payable, short-term debt, accrued liabilities and any other debt which is payable within the current calendar or financial year. Usually, a business will need to cash-in Current Assets in order to pay off Current Debt.
Current Assets - Are assets of a business which are likely to be converted into cash, sold or consumed within a single operating cycle of the business, typically a calendar year or financial year. These are likely to include cash in hand, accounts receivable or any other monies due in that timeframe, as well as stock held by the business.
Current Liabilities - Also known as Current Debt. These are obligations which the business must meet within one year, or less, of the date of a financial statement. Current Liabilities will appear on the business balance sheet and includes accounts payable, short-term debt, accrued liabilities and any other debt which is payable within the current calendar or financial year. Usually, a business will need to cash-in Current Assets in order to pay off Current Liabilities
Debt Financing - Money that you borrow from another source, with the understanding that you will pay it back within an agreed period. In other words – a loan. This can be short-term (a year or less) or longer term. Debt Financing is not to be confused with Equity Financing, in which a company is granted a loan in return for a share of the business. This normally occurs with an Angel Investor or Venture Capitalist or may be a result of issuing shares in a public offering.
Depreciation - An accounting term which refers to the cost of a fixed asset in a business being spread over a fixed period, typically the operating life of that asset. For example, if a business pays R1 million for a piece of machinery and expects it to have a useful life of five years, it will depreciate it at a rate of R200 000 per year (assuming straight-line depreciation). Depreciation is a non-cash expense which lowers the reported earnings of a business, while at the same time increasing cash flow.
Equity - That portion of an organisation’s assets owned by shareholders (including a sole proprietor or partners), as opposed to what they have borrowed. Also known as ‘owner’s equity’ or ‘shareholder’s equity’, it is equal to total assets minus liabilities and appears on the balance sheet. In investment terms, Equity refers to ‘stocks’ and is one of the principal asset classes
Expense - Money spent, assets expended and services consumed by a company in the course of its income-generating business operations. These include rent, salaries, electricity, office supplies, etc. Expenses appear in the income statement and are a deduction for tax purposes.
Fiscal Year( ‘financial year’ or ‘budget year’) - It is a period of 12 consecutive months used for calculating the annual financial statements of a business. A Fiscal Year need not be a calendar year and, in South Africa for example, the government’s Fiscal Year begins on March 1 and finishes on February 28 the following year. In such cases, it carries the name of the year in which it ends.
Fixed Cost - An expression used in short-term accounting to describe costs that are likely to remain relatively unchanged over a designated period (such as a Fiscal Year). These costs include salaries, wages, rent, insurance, interest and depreciation. It is the opposite of costs which may vary depending on production or sales levels.
Fixed Liabilities - A company’s long-term debts which are payable over a timeframe longer than a year. These are typically debts such as mortgages, loans and bonds. It is the opposite of Current Liabilities like salaries and Accounts Payable (see listing under ‘A’). Also known as ‘long-term liabilities’.
Goodwill - An accounting term for the intangible asset which accrues to a business or brand when it has a positive reputation and strong recognition within its target market. Other elements which can contribute to Goodwill include employee satisfaction and customer loyalty. The presence (or absence) of Goodwill becomes important when a business is valued or sold, and finding the correct ‘value’ in any given situation is a global problem. Marketers in the US are currently working with the accounting profession to set nationally-accepted valuation guidelines for this.
Gross Margin - The margin of profit that a business makes from its activities. It is the difference between the selling price of a product or service and the cost of bringing that product/service to market. Typically expressed as a percentage, it is calculated as gross revenue minus direct costs. Also known as ‘gross profit’.
Gross Profit - The margin of profit that a business makes from its activities. It is the difference between the selling price of a product or service and the cost of bringing that product/service to market. Typically expressed as a percentage, it is calculated as gross revenue minus direct costs. Also known as ‘gross profit’
Income Statement - One of the three major financial statements (the others being the balance sheet and cash flow statement) it is drawn up either monthly or annually and reports on the ability of the business to generate cash. An Income Statement lists elements such as income; operating expenses; total expenses; depreciation; net profit; interest; pre-tax earnings; and net profit after tax. It is also known as a ‘profit and loss statement’.
Interest Expense - Also known as ‘interest payable’, it is the amount of interest a business must pay on money it has borrowed. Interest Expense is found in the income statement and lists the interest owed to all providers of long-term and short-term loans during the specified accounting period.
Inventory - Merchandise in stock but not yet sold, unfinished products, and raw materials are all part of the Inventory of a business and are categorised as liquid assets because they can relatively easily be converted into cash. For a company, particularly in the manufacturing or import sector, Inventory is a key part of the overall asset base. Careful Inventory management is also an important challenge for a business, as over-stocking ties up capital, while having too little stock reduces sales and harms customer relationships.
Liabilities - Debts and obligations which arise during the normal course of a company’s operations. Liabilities are displayed in the balance sheet and will include Accounts Payable, accrued expenses, loans, mortgages, etc. Current Liabilities are payable within a year, while Long-term Liabilities are payable over an extended period.
Long-term Assets - A measurement of the value of a company’s capital assets such as property and equipment, minus depreciation. Long-term Assets are reported on the balance sheet and are usually recorded at the purchase price, rather than the current market value of the asset. In general, it applies to assets with a lifespan in excess of five years.
Long-term Liabilities - Debts which are due to be paid in more than a year, as opposed to Current Liabilities, which are due to either on-demand or in less than one year. Long-term liabilities may include bank loans, leases and bond repayments.
Loss - The amount by which the cost of operating a business exceeds its revenue during a given timeframe, typically a month or a financial year. The opposite of Profit, it will normally be reflected in the profit and loss statement or Income Statement.
Net Cash Flow(Cash Flow) - It is the movement of cash into and out of a business during the normal course of its operations and usually measured over a specified period of time. A strong and positive cash flow is a healthy business indicator and is determining by: Cash income less cash payments (e.g. operating expenses, rent, etc.) for the specified period.
Net Profit(Net Income, Net Earnings, or Profit after Tax) - It is the amount by which income within a business exceeds expenditure. Net Profit is calculated by subtracting total expenses from total revenue, thus indicating what a business has earned over a set period – usually a calendar year or financial year.
Net Worth - A term which can be applied to both individuals and companies, it is the amount by which assets exceed liabilities. In the business environment, it is commonly known as shareholders’ or owners’ equity and is determined by subtracting liabilities from assets on the balance sheet
Payables(Accounts Payable) - It is an accounting term for money which a business owes to a supplier of a product or service that the business has obtained on short-term credit. An accounts payable entry will normally be listed on a balance sheet under the heading of ‘current liabilities’. In larger organisations, ‘accounts payable’ may refer to an individual or department dedicated to handling the payment to suppliers and other creditors.
Profit & Loss Statement(P&L, Income Statement) - It is one of the three major financial statements (the others being the balance sheet and cash flow statement) it is drawn up either monthly or annually and reports on the ability of the business to generate cash. A Profit & Loss Statement lists elements such as income; operating expenses; total expenses; depreciation; net profit; interest; pre-tax earnings; and net profit after tax.
Profit Margin - A measure of how much out of every rand that a company keeps in earnings. Usually expressed as a percentage, it is Net Profit (see listing under ‘N’) divided by Sales. A higher profit margin typically indicates that a business has good control over its costs, or that it has established itself as a premium brand and can, therefore, increase its prices more than its competitors, while still offering a similar product.
Pro-forma Income Statement - A projection of expected future financial performance, as opposed to an actual income statement, which records figures for a period which has already passed. It is a useful management tool in that it helps to identify areas where desired performance may be lacking, enabling early corrective action to be taken
Pro-forma Invoice - A price quote in which the potential seller provides the potential buyer with the selling price and any other applicable charges, commissions and fees. This ensures that the buyer knows the full price of the transaction before proceeding with the purchase. A Pro-forma Invoice is particularly common in export transactions.
Receivables Turnover - An accounting term which describes a company’s efficiency in extending credit to its customers and collecting its debts. A high Receivables Turnover ratio indicates that a business has efficient credit and collection policies (or that it deals in cash). Conversely, a low ratio indicates it is not properly assessing the creditworthiness of its customers, and/or that collection procedure are inefficient. The ratio is measured via the following formula:
Net credit sales ÷ Average accounts receivable
Retained Earnings(Retained Surplus or Retention Ratio) - This is the percentage of net earnings which is not paid out to shareholders as a dividend but is instead retained by the business to re-invest in its operations or to pay off core debt. In accounting terms, Retained Earnings is a general ledger account and is adjusted each time an entry is recorded in an income or expense account.
Return on Assets(ROA) - It is a measurement of the earnings which have been generated by the invested capital in a business. The figure tells investors, the board of directors, and senior management how effective the company was in converting that capital into assets of value. The ideal is to make large profits from little investment. ROA is measured as a percentage and the formula is calculated as follows:
Net income ÷ Total assets
Return on Investment(ROI) - It is a measurement of the earnings which have been generated by the invested capital in a business. The figure tells investors, the board of directors, and senior management how effective the company was in converting that capital into investments of value. The ideal is to make large profits from little investment. ROI is measured as a percentage and the formula is calculated as follows:
Net income ÷ Total Investments
Stock Turnover -
Also known as Inventory Turnover. It is an accounting measure of the number of times that the average stock on hand is sold and replaced during a given timeframe, usually a month or financial year. A low figure may indicate poor sales strategies, incorrect reading of market requirements, or over-stocking. Conversely, a high figure indicates the opposite and is a positive sign for the business. The equation to determine Stock Turnover is:
Cost of good sold ÷ by average stock = stock turnover
Sales Break-Even( Break-Even Analysis) - It is a method of determining at what point a company’s financial situation is in equilibrium and it makes neither a profit nor a loss. In doing a Sales Break-Even analysis, management will typically calculate the volume of sales and/or income required to cover the costs associated with producing it. If sales/income is predicted to fall below this point, then the operation is deemed unviable or in need of further action, for example reducing the unit cost of producing the item.
Sales on Credit(Credit Sales) - It is products and services sold on the understanding that payment will be made at a later, mutually agreeable, date. This may involve payment via a single lump sum – over 30 to 90 days, for example – or payment in instalments over a period which may last for several years. In the latter case, this will frequently involve an interest payment as well. The opposite of Cash Sales.
Short-Term Assets(Current Assets) - These are assets of a business which are likely to be converted into cash, sold or consumed within a single operating cycle of the business, typically a calendar year or financial year. Short-Term Assets are likely to include cash in hand, accounts receivable, or any other monies due in that timeframe, as well as stock held by the business. In investment terms, it is a security which matures in one year or less.
Sole Proprietor - The simplest form of business structure, where a single individual is a sole owner is the business. Although Sole Proprietors often trade under their own name, there is no requirement to do so and the business may have employees and operate in most sectors of the economy. Profits from the business are viewed as personal income and taxed accordingly. One of the downsides is that there is no limited liability under the law, and the Sole Proprietor is therefore personally responsible for all debts incurred.
Short-Term Liabilities(Current Debt or Current Liabilities) - These are obligations which the business must meet within one year, or less, of the date of a financial statement. Short-Term Liabilities will appear on the business balance sheet and include accounts payable, short-term debt, accrued liabilities and any other debt which is payable within the current calendar or financial year. Usually, a business will need to cash-in Short-Term Assets in order to pay off Short-Term Liabilities.