The Financial Accounting Standards Board (FASB) published the GAAP (Generally Accepted Accounting Principles) in order to create a uniform system of accounting among all business for auditing and taxation purposes. As a business owner, you must comply with GAAP standards and record your financials in the same system using the same principles as nationally prescribed.
It can be difficult to discern these principles and what the vocabulary means when you haven’t gone to school for accounting or bookkeeping. We have put together a beginner’s guide to GAAP and the vocabulary to better understand what process you need to implement for your company.
The 2 Methods of Accounting
Cash
This method of logging transactions records income when the business receives it and expenses when they pay them. Therefore, transactions that spread multiple quarters are recorded only when they are actually paid or received. This method does not recognize incoming or outgoing money like accounts payable and accounts receivable. This is sometimes considered the easier way to log finances.
Accrual
Cash basis accounting is not considered an accepted accounting practice by GAAP, but accrual basis accounting is accepted. Accrual basis accounting records transactions when they occur, regardless of when the cash is exchanged. This way, accounts payable and receivable are essential to measuring financial health. This method of accounting is argued to be a better way to assess your company’s financial standing and is the way most CPA’s will set up your records.
Vocabulary
There are some frequently used terms that are important to be aware of when you are dealing with bookkeeping. Here are some accounting and other terms you need to know as a business owner:
Accounts Payable (AP): These are loans, credits, or anything you owe in any sort of transaction that is not yet paid. Accounts payable is recorded as a liability.
Accounts Receivable (AC): Relates to any money you are owed via customer payments for goods or services rendered. These are considered assets.
Accruals: Revenues earned but not yet entered, such as non-invoiced sales or incoming expenses. These are different than AP or AC.
Amortization: The process of spreading out the record of a transaction over multiple periods of time. An example is monthly payments for a piece of equipment.
Assets: Any tangibles or intangibles a company owns or is owed that adds monetary value. Assets include all of the company’s bank accounts, capital, accounts receivable, office equipment, land, patents, customer lists, and anything else that adds to the value of the company.
Bad debt expense: These are debts that are unpaid by the customer. If they default on an account payable, this is recorded as a bad debt expense and a liability.
Balance sheet: A type of financial statement that focuses on two columns: assets and liabilities. Equity is factored at the bottom and together assets must equal equity and liabilities. This financial statement shows a snapshot of a business’s financials for one period of time (for example, the month of January or the past fiscal year).
Capital (Working capital): All assets leading a company to production. Capital is also a measure of a company’s overall liquidity, or ability to pay its liabilities.
Net Working Capital = Current Assets – Current Liabilities
Cash Flow: The total amount of money flowing in and out of a company.
Cash Flow statement: A financial statement performed to measure the cash generated and used by a business in a specific period of time.
Cash Flows from Operations = Net income + Noncash Expenses + Changes in Working Capital
Depreciation: When an asset loses value over time, such as a vehicle or piece of equipment, the loss of value is recorded against the total value of the asset.
Equity: The value of owner’s ownership in a company after liabilities have been subtracted.
Expenses: Anything that leads to an outflow of cash - it does not have to be an immediate “cost” and is recorded differently based on accounting method.
Fiscal Year: 12-month cycles of a business. This does not need to start on January 1st but does need to be consistent year over year for taxation purposes.
General ledger: Where most bookkeeping activities lie; A record keeping system for all debit and credit records as validated by a trial balance.
Income statement: A financial statement that asses all revenue against expenses to measure a company’s ability to generate net income (profit).
Liabilities: Anything that is considered a debt by the company.
Revenue: Inflow of cash or assets (accounts receivable). Subtracting expenses from revenue creates profit.
Don’t know where to start? Consider hiring a bookkeeper to have your back!