Terms & Definitions

The Fundamental Accounting Equation:

Income = Revenue – Expenses

Accounting
Accounting is the systematic recording, reporting, and analysis of financial transactions of a business. Accounting allows a company to analyze the financial performance of the business, and look at statistics such as net profit.
Asset
Asset is any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car, and other property. On a balance sheet, assets are equal to the sum of liabilities, common stock, preferred stock, and retained earnings.

From an accounting perspective, assets are divided into the following categories:

  • current assets (cash and other liquid items)
  • long-term assets (real estate, plant, equipment)
  • prepaid & deferred assets (expenditures for future costs such as insurance, rent, interest)
  • intangible assets (trademarks, patents, copyrights, goodwill)
Balance Sheet
Balance Sheet is a quantitative summary of a company’s financial condition at a specific point in time, including assets, liabilities, and net worth. The first part of a balance sheet shows all the productive assets a company owns, and the second part shows all the financing methods (such as liabilities and shareholders’ equity).
Liability
Liability is an obligation that legally binds a company to settle a debt. When one is liable for a debt, they are responsible for paying the debt. A liability is recorded on the balance sheet and can include accounts payable, taxes, wages, accrued expenses, and deferred revenues. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period.
Shareholders' Equity
Shareholders’ Equity is an ownership interest in a corporation in the form of common stock or preferred stock. It is calculated by taking the total assets minus total liabilities; here also called shareholder’s equity or net worth or book value. For sole proprietors it is often called Owners Equity.
Income Statement
Income Statement is an accounting of sales, expenses, and net profit for a given period. An income statement depicts what happened over a month, quarter, or year. It is based on a fundamental accounting equation. (Income = Revenue – Expenses) and shows the rate at which the owners equity is changing for better or worse.
Revenue
Revenue is the total amount of money received by the company for goods sold or services provided during a certain time period. It also includes all net sales, exchange of assets; interest and any other increase in owner’s equity and is calculated before any expenses are subtracted.
Accounts Payable
Accounts Payable is money which a company owes to vendors for products and services purchased on credit. This item appears on the company’s balance sheet as a current liability, since the expectation is that the liability will be fulfilled in less than a year. When accounts payable are paid off, it represents a negative cash flow for the company.
Accounts Receivable
Accounts Receivable is money which is owed to a company by a customer for products and services provided on credit. This is often treated as a current asset on a balance sheet. A specific sale is generally only treated as an account receivable after the customer is sent an invoice.
Accrual Basis Accounting
Accrual Basis Accounting is an accepted form of accounting that reports income when earned and expenses when incurred. Under the accrual method, companies do have some discretion as to when income and expenses are recognized, but there are rules governing the recognition. In addition, companies are required to make prudent estimates against revenues that are recorded but may not be received, called a bad debt expense.
Expense
Expense is any cost of doing business resulting from revenue generating activities.
Cash Flow Statement
Cash Flow Statement is a summary of the actual or anticipated incomings and outgoings of cash in a firm over an accounting period (month, quarter, year).

It answers the questions:

  • Where the money came (will come) from?
  • Where it went (will go)?

Cash Flow Statements assess the amount, timing, and predictability of cash-inflows and cash-outflows, and are used as the basis for budgeting and business planning.

The accounting data is presented usually in three main sections:

  1. Operating activities (sales of goods or services),
  2. Investing activities (sale or purchase of an asset, for example), and
  3. Financing activities (borrowings, or sale of common stock, for example).

Together, these sections show the overall (net) change in the firm’s cash flow for the period the statement is prepared.

Accounting Method
Accounting Method is a process used by a business to report income and expenses. Companies must choose between two methods acceptable to the IRS, cash accounting or accrual accounting.
Cash Basis Accounting
Cash Basis Accounting is an accepted form of accounting that records all revenues and expenditures at the time when payments are actually received or sent. This straightforward method of accounting is appropriate for small or newer businesses that conduct business on a cash basis or that don’t carry inventories.