While there is a glossary of finance terms, we’ve listed eight important bookkeeping jargons that every small business owner must first understand to stay on top of your game.
If you don’t have a bookkeeping background, your financial word bank could fall short and that would make it difficult to stay on top of your numbers.
1. Bank reconciliation. When you need to match your bank records with your books, the process is called bank reconciliation. This is an important procedure that a small business owner should undertake to ensure that all your cash records are correct. If there are any differences, it is important for you to note the changes in your bookkeeping records as they are appropriate.
Generally, you should perform this process at a regular interval. It is ideal to conduct a bank reconciliation when you receive your bank statement at the end of each month. But you can also do this on a daily basis as you can access your month-to-date information through your bank’s website.
When you conduct a regular bank reconciliation, you prevent encountering some painful problems in your business. It helps you—
Resolve cash balance issues
Prevent bounced checks
Avoid overdraft fees
Prevent or report fraud
Detect unauthorized ACH debts
2. Cash flow statement. How you make money and how you spend it for a period of time is found in your cash flow statement. Small businesses generally have a tight cash flow that makes it important to understand what comes in and what comes out of your accounts for you to be able to manage your cash wisely.
The life of your business depends on your cash flow. If you run out of cash, you close your business. It helps to complete your cash flow analysis regularly to meet your targets and keep your business healthy.
3. Current Ratio. Ratio means proportion. It is the proportion showing the comparison between a company’s current assets and liabilities. For non-bookkeeping business owners, current ratio is your window to peek into your company’s liquidity and the general financial health of your business. It gives you the information whether you are able to pay for your obligations or your accounts payable in the coming year.
If you need the current ratio formula, the video below shows you a step-by-step guide to calculate for your current ratio and discusses ways you can apply it to evaluate your company’s financial health.
4. Double entry bookkeeping. This is a two-part method of entry in the bookkeeping records: debit and credit. It is a bookkeeping system that suggests every financial transaction has a positive and negative entry. It is a fundamental concept in bookkeeping and bookkeeping today used in order to fulfill the formula,
Assets = Liabilities + Equity
Each entry in the debit account has a corresponding opposite entry in the credit account so that both is always equal but opposite that keeps the books balanced. This method makes it easier for financial advisors to determine any error in the books if the debits and credits don’t match.
If all entries are made properly and the books are balanced, it makes it easier to complete your business financial statements.
It sounds complicated and a lot of work. But you can speed up your bookkeeping tasks by using automation. Bookkeeping systems such as QuickBooks makes it easier to capture your transactions automatically and the double entry method is done for you by the system.
5. Financial year. This is your yearly bookkeeping calendar. It is the year that you earn an income. Another name used is fiscal year that also refers to the 12 consecutive monthly periods. It is easy to get confused when you refer to the IRS statement defining financial year as the "12 consecutive months ending on the last day of any month except December 31st."
The Balance website explains the confusion by identifying your business financial year as an internal matter while your tax year as external. When it is internal, it means you report to yourself or to your shareholders. The tax year is the period of 12 consecutive months that you report to the IRS for your business tax.
Generally your financial year and your tax year are almost always the same. It’s important for your business to have a financial year for tax purposes.
6. NPAT (Net Profit After Tax). This is the business metric that shows you the overall company profit. It is important that you understand this and the difference against net income (before tax).
As the term suggests, net income before tax is what you see in your income statement showing the total amount of all the revenues less the total expenses, which includes costs of goods sold and income taxes. After subtracting all the taxes, you get the net profit after taxes. It is your bottom line profit.
If your net profit after tax is large, it is a good indicator of a profitable business.
7. Variable costs. These are costs that vary or change based on your production. If you are in the business of making bread, you need to buy ingredients like sugar, milk, flour, and eggs. Your cost for the ingredients depends on the quantity of bread you are making, and it’s called variable costs.
Understanding what are your variable costs is critical to small businesses that helps you forecast your monthly expenses. You may reduce or increase your variable costs based on production demand. If you are forecasting a high demand for December production, you can allocate higher budget for your variable costs. The same applies if the following month is a lean season that means you should lower your production and reduce your variable costs.
8. Working capital. Subtract your current liabilities from your current assets and you get a good indication of your working capital, which is the available cash that you are using to fuel your daily business operations. If you have a negative working capital, it means your business is financially struggling that could break your business as you can not continue with your day to day business activities without cash.
The list of finance terms that you must understand when you own a business or starting one is long and it will take more than one article to list them all. But these most important terms will get you started to help you balance your books at the end of the financial year.
Alternatively, you can always employ a trusted financial advisor to help you understand what you need to know when it comes to bookkeeping for your business to grow profitably.
We help you plan, forecast and analyze your financial data
so you can get on top of your finances today to grow your small business big tomorrow.
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