Essential Bookkeeping Terms

It is important to understand essential bookkeeping terms but they are not a part of everyday life. Which, between the rules you need to learn to properly handle and classify your spending/receiving and then these terms, it can quickly become overwhelming.

This leads to people putting off and neglecting their bookkeeping. I'm here to help you gain confidence and tackle your bookkeeping tasks!

Below are the essential bookkeeping terms that you should know.

Cost of Goods Sold (aka COGS)
Your COGS is the money you spent to get your product to the point of being sold.

If you are a producer or manufacturer, you will have higher COGS than say a retailer or service-based business.

Think of this as the direct cost to get your product to a complete and finished state. Things like raw materials, parts, direct labor and direct factory overhead.

Get it? It is the → cost of ← getting your → goods ← to the point of being → sold!

I view this as one of the most straightforward aspects of accounting.

Expenses
An expense is a business’s indirect costs.

If it has to do with selling, general or administrative costs (also called SG&A), this is where it will go.

Things like advertising/marketing, bank fees, insurance, repairs/maintenance and administration/general payroll; basically all the other costs of doing business.

Gross Income
This is all the money you have received from your services and or goods.

Think top line.

Gross profit
Looking at your gross profit can be equated to showing your profitability after the cost of production.

It takes your gross income, subtracts your COGS and you get your gross profit.

Net income
Net income is your bottom line. It is your gross profit minus expenses.

If your net income is negative, that means you spent more on your COGS and expenses than you had income coming in.

Most start-ups are negative the first year or two of business so do not start panicking if you are operating at a net loss. If you are actively getting new sales and strategically managing your spending, this will turn around.

Looking at your net income at the end of year is a great gauge of what you will be taxed on.

Please note that this is a rough gauge, because a LOT goes into calculating a return and there is no simple calculation to share with you.

Assets
There are two types of assets – tangible and intangible assets.

Tangible assets are things you can physically touch and physically have. This includes bank accounts (because you can pull out the cash), cash on hand, land, buildings, vehicles and inventory, to name a few.

Intangible assets are non-physical things like patents, intellectual property, copyrights, trademarks and receivables (which I will explain below).

As of the 2022 tax year, the IRS considers a single item over the cost of $2500, to be an asset. If it is below that mark, it should be expensed.

Let’s say you buy a fancy shmancy printer for $1500. This belongs in an account like Office Supplies Expense, not as an asset. While it is a physical item, and in a sense an asset, in terms of bookkeeping, it should be expensed and not capitalized to an asset.

Liability
A liability is what you owe someone else or another entity.

This is where you would find the balance of any credit cards, vehicle loans, building mortgage, payroll taxes and loans from officers (when an owner loans the business money, but expects to be paid back).

Equity
Of all these terms, equity is the hardest to simply and fully explain. This is because of all the different situations that create so many different explanations.

Essentially, this is what you have built, monetarily, into or out of your company.

If you were to sell tomorrow, this is one of the key sections that the professionals will analyze and evaluate your worth to be.

My biggest piece of advice is to ask your bookkeeper or CPA about your specific equity questions, if you have any or click here to join my free Facebook group and ask away!

Receivable
Receivables are the best part of all of this – it is the money that is owed to you!

Any invoice that gets created and sent to your customers/clients but not immediately paid, gets “stored” here.

This is why receivables are intangible assets, because it is not a physical item, yet. Once that invoice gets paid, then that money is a tangible asset.

Profit and Loss
Profit and Loss is an essential report you can pull that ultimately tells you your income, COGS broken out, gross profit, expenses broken out and net income. This report can also be referred to as Income Statement - they are one and the same.

When I say broken out, if you went to Staples 6 different times and spent a total of $854.62 on office supplies and categorized it as such with no other entries into office supplies, your profit and loss statement will have a line saying Office Supplies Expense and list $854.62 along with all the other categorized transactions you have entered.

Your Profit and Loss is a snapshot of your business at a specific time frame.

Balance Sheet
Your balance sheet is another essential report. It shows you what the balance of your all your key accounts; bank accounts, cash, accounts receivable, assets, liabilities, and equities.

Basically laying out what you have (money and assets), what is owed to you (receivables), what you owe (liabilities) and what you have built (equity).

To be completely frank, the balance sheet is what confuses most people who a) never had an experience with it b) never been formally educated on it and c) may not have an analytical mind. I legitimately had to teach humans who graduated with an accounting degree certain aspects of the Balance Sheet when working at an accounting firm. So give yourself some grace when trying to learn this new concept - it's tricky!

Just remember, people go to school for this, so it is not something that is naturally intuitive and most business owners pay people to handle this for them.

The P&L is easier to understand because it reflects the money you received and the bills you paid within the time period you pulled the report for. Pretty straightforward.

The Balance Sheet is an accumulation from day one and the numbers reflected is the balance of all the accounts on the last day of the time period you pulled the report for.

So, let’s say that it is June 14 but you pull a report for first quarter; January 1 – March 31. The numbers reflected on this report will show the balance of your accounts as of March 31.

If you made a credit card payment on April 1, it will not be reflected on this report unless you change the dates to be January 1 – April 1.

Being a bookkeeper by trade, there is not a time I have been in someone’s books and have not reviewed these reports to ensure accuracy, completeness and spot anomalies.

These two reports are essential to every business, no matter the size.

If you have any questions about these essential bookkeeping terms, or any other term you are unsure of, please comment below or join my FREE Facebook group! I would love to see you there.