25 Essential Finance and Accounting Terms Everyone Should Know

05-Sep-2024

Having a good grasp of finance and accounting terms is essential in managing finance efficiently and making important business decisions. Understanding organizational or personal finances demands knowledge of the business tongue. As financial accounting is considered the universal business language, knowledge of fundamental finance and accounting terms is crucial. 

Accounting in simple terms is the practice of recording and communicating an organization or individual's financial transactions and information. Contrary to the general misconception of restricting the application and importance of finance and accounting only to finance and accounting professionals, knowledge of financial accounting is a critical business skill for every profession.

Through this blog, let us identify the 25 essential finance and accounting terms that everyone should know. Knowledge of these key finance and accounting terms will help you understand your numbers better. While accounting pros need them for managing general business and record keeping,  ordinary individuals also need them for tax purposes and legal reasons. 

Key Finance and Accounting Terms and Concepts

1. Accounting Period: This term is used to imply the period in which an organization's economic data is recorded for accounting. The accounting period varies depending on the business and ranges from one month to a quarter or a year. In simple terms, it is the time period that is covered by financial statements. 

2. Accounts Payable (A/P): AP describes all the unpaid amounts/expenses ideally recorded as bills due to the business. On a business balance sheet, it is recorded as a current liability. In simple terms, it is the amount of money due to be paid for a product or service received by an individual/business to creditors or suppliers. This could include anything like rent, utility bills, etc. 

3. Accounts Receivable (A/R): AR is the term used to describe the amount of money owed to an individual or a business for sell of products or services. On a business balance sheet, it is recorded as a current asset. 

4. Assets: The term assets means the resources a business or an individual owns. It is anything of value both tangible and intangible that a business owns. It includes building, land, Cash, A/R balance, and Inventory. Intangible assets will include trademarks and copyrights. Assets are generally categorised into two types- Current Assets and Fixed Assets. Assets that are convertible into cash within one year are called Current Assets and this may include cash, accounts receivable or Inventory. Fixed Assets on the other are the long-term assets that provide benefits for over a year and long-term sustainability. This may include - property, real estate, tools and machinery, stock, etc.

5. Amortization/Allocation: This term describes the process of allocating or spreading expenses/costs across numerous accounting periods on the balance sheets. For instance, you purchase equipment and can allocate/amortize the cost and the expenses incurred in purchasing the product across multiple accounting periods/several years. 

6. Balance Sheet: A balance sheet is a financial statement/ a master record of an organization that records and shows a company's assets, liabilities and equity. It is a record showing what a business owns and owes. Balance sheets are generally discussed side by side with income statements showing the income and expenses of a business during a set period.

7.  Cash Flow: The term cash flow is used to describe the inflow or flow of revenue (cash) in a company within a select time period through its business activities. 

8. Audit: Audit is a process of reviewing a company's financial activities and records by an independent auditor to corroborate accuracy and adherence to accounting standards and legal financial norms. 

9. Capital (CAP): Capital is the amount of money a company can use to operate their business and grow. It also includes the financial assets which can be in the form of cash or non-cash that a business can leverage or liquidate for laying out business activities. It is a set potential amount that a company could spend and is not the actual amount of expenditure that a company spends.  

10. Credit: It is an accounting record that indicates liability increase or assets decrease depending on the manner of the transaction. Usually, its entry in the accounting transaction is made on the right side. 

11. Debit: It is the reverse of credit and it indicates a transaction that leads to an assets increase or liability decrease. 

12. Depreciation: The term means a value decrease in the fixed asset over a period of time caused by wear and tear or becoming obsolete. Examples may include the company's vehicle, machines or tools, etc,

13. Diversification: The term is used to describe the process of diversifying or variegating a company's resources into various multiple assets to mitigate risks or reduce the adverse impact of a single untoward event. 

14. General Ledger: GL is a company's complete record of financial transactions which is also used for preparing a company's financial statements. A General ledger includes every business transaction made, including, sales, credit, purchases, income, profit, losses, office expenses, etc. 

15. Liquidity: This term refers to how quickly a company's assets can be converted into cash. For instance, stocks have higher liquidity than property/land/house as it is convertible into cash more quickly while selling a house would take longer. 

16. Overhead: The term refers to the expenses incurred in running the business like office rent, salary for employees, etc. 

17. Return on Investment (ROI): The term in today's business era indicates the money/profit generated through an investment by comparing it with the cost of investment. It is usually expressed in percentages and calculated by dividing the net profit by the investment cost. 

18. Trial Balance: A trial balance in a record in the general ledger stating debits and credits of a single particular account. The record must tally with debits and credits.

19. Liability: A liability is an amount that a business owes. It can be in varied forms like accounts payable, accrued expenses, and taxes. etc. Liabilities are categorised into three major types: 

• Current Liabilities - Debts that must be paid back within a year 
• Non-current Liabilities - Loans like bonds or mortgages that take over a year to repay
• Contingent Liabilities- These are liabilities conditional upon the consequences of a future event.

20. Insolvency: The term refers to a situation where an individual or a business is unable to pay its debts. It is estimated by calculating all expenses to revenue. If the revenue is inadequate to cover expenses, insolvency occurs inevitably. 

21. Inventory: Inventory refers to a list of the company's products or goods to be sold out. It is categorized into

• Finished goods - where products are sale
• Work-in-progress good- where products need to be assembled 
• Raw materials- resources that will be converted into other finished goods over time. 

22. Gross Profit: It refers to the profit of a company concluding overhead expenses. It is typically included in calculating and evaluating a company's value. A Gross profit is often required to show the company's potential in securing a business loan or pitching business propositions to investors. 

23. Equity-  This term represents a company's business value. There is owner's equity which reflects how much a business or person owns, property equity which shows the number of mortgages paid and stock equity which shows the percentage a company owns through stocks. The equity of a company is calculated by taking the difference between liabilities and assets on the balance sheet. 

24. Income Statement: This is a term referring to a company's financial statement showing its cost, expenses and revenue over a stipulated time period. The statement begins with revenues generated from which expenses are deducted and arrives at an amount reflecting either lost or profit. 

25. Accrual- The term is used to refer to the record of revenues generated and expenses incurred by a company which impact its net income but have not been recorded in the financial statement of the company. Revenues are recorded regardless of the time of the received payment. Expenses are recorded at the time it is incurred.

Besides these 25 terms, let us also explore some common accounting terms under diverse accounting practices that will prove beneficial for those in business or who are running personal enterprises. 

Book Value (BV): When an asset is depreciated it loses its value. However, on the Balance sheet, the  Book Value will reflect the asset's original value minus any accumulated depreciation. The Book Value of a company may be derived by totalling the value of all the assets the company owns minus its liabilities. It is equal to its equity. 

Cost of Goods Sold (COGS): This term reflects the expenses incurred in creating or manufacturing products or services.  Apart from the cost incurred for running a business, COGS includes the cost of labour involved in providing a service and the cost of materials. 

Expenses: Expenses are the costs paid by a company. There are four categories of expenses in business, namely

• Fixed Expenses: These are payments that remain the same over time- like rent or mortgage
• Variable Expenses: Included payments that are made regularly like replenishment and supplies for inventory and labour
• Accrued Expenses: Payments yet to be done
• Operational Expenses: includes payments for taxes, advertisements, etc.

Gross Margin (GM): This accounting term reflects the profitability of a business calculated after taking out the Cost of Goods Sold. GM is a percentage derived by dividing gross profit (GP) by revenue within the same period.

Gross Profit (GP): GP shows the company's profitability. It is calculated by deducting the total costs/expenses incurred in the production and selling from the income generated. It is also referred to as Gross income or sales profit. 

The formula for calculating GP: GP= Total Revenue - Total COGS

Net Income: It is the remaining amount of profit after all deductions are made and expenses paid. It is the income from sales made by a business. NI is calculated by subtracting the sum of all the expenses- COGS, taxes, Depreciation, and Overhead from the revenue made within a given period. 

Net Margin: Net margin is the profitability ratio for determining a company's net profit against one rupee of its revenue. Net Margin reflects the company's total revenue and net profits. It is calculated by deducting all the expenses incurred including - GOGS, Admin Overheads (salary) R&D costs, Depreciation, Debt interests, and Taxes from the revenue generated. 

Net Margin Calculation Formula: Net Margin = Net income/total revenue x 100

Revenue: It is any profit in money that a business earns by selling its products or services. 

Business Legal Entity: A business entity is a legal organization or an individual who oversees and defines the responsibilities and structure of a business and the legal framework within which the business or organizations must operate and comply. 

Interest: It is a monetary charge paid in addition to a principal amount for a loan or credit. 

On Credit/Account: It is a kind of transaction where purchases are made with a promise to pay the cost in the future. 

Payroll: Payroll is a term that is used to describe payments made to employees as wages, salaries, bonuses or any deductions. On a balance sheet, Payrolls are recorded as liabilities in the event of any unpaid wages or vacation pay. 

Present Value:  The term Present Value specifically denotes the current value of a future sum of money or a stream of cash flow at a stipulated rate of return.

Bookkeeping: It refers to the practice of recording the financial transactions of a business and maintaining the record daily. It records the inflow and outflow of money from the organization. Bookkeeping plays a critical role in keeping track of the business's financial activities and helps in successful business operations. 

The above compilation is created to give you a broad idea about finance and accounting terms that are generally used in business. While varied professions have different profession-specific languages, every organization enters into an accounting business. Regardless of what profession you practice, learning these terms and business language will keep you afloat in your financial accounting dynamics and also help you in your financial matters. 

Essential Finance Terms Essential Accounting Terms essential finance and accounting terms