Bookkeeping Terms Every Business Owner Should Understand (Part 1)
These bookkeeping terms are part of a broader small business bookkeeping guide that helps owners understand their numbers with confidence.
To run a successful business, there are a handful of basic bookkeeping terms that you should become familiar with. Terms like cash flow, profit, expenses, revenue, and income are just a few off the top of my head because those are the ones that you will see pop up most often. Places like your Profit & Loss (P&L) Statement, bank statements, or whenever you are having a conversation with your bookkeeper or tax professional. Once you have a general understanding of these terms, your statements and balance sheets look less like a foreign language and start to make sense.
Knowing these at a bare minimum helps you to make better decisions for your company overall. They help you get a snapshot of what is really going on inside your business and allow you to spot potential problems early on, like issues with cash flow or unexpected bills. With proper information and understanding, it will allow you to better understand your financial reports and help you stay in control of your business finances.
Having a better understanding of these terms will allow you to know how money is moving in, out, and around your business, and ultimately, make the appropriate decisions on how to plan and grow your company.
Accounting Basics
Revenue
Revenue is the money that comes into the business from providing a service or selling a product. It is the income generated from conducting everyday business activities, but before any expenses are taken out. It doesn’t matter what you offer, products or services; revenue is what the business has earned and not necessarily what it has received yet.
There is an important distinction to make though; revenue isn’t always counted as the money hits your business bank accounts. It counts as revenue only when the work, service, or product is provided to the customer. An example of this could be when you invoice a customer for work completed. This is considered revenue even though they may not have even paid you yet. Conversely, when a client prepays for services that haven’t been received yet, this money cannot be recognized as revenue quite yet because the service hasn’t been performed or completed yet.
Recognizing revenue this way will help you to have a more accurate picture of how the business is doing and keeps your financial reports up to date and accurate. Not just relying on what is sitting in your bank account.
Expenses
Expenses are the costs that you incur to run your business day to day. Tracking expenses correctly helps the business owner understand where money is flowing, and it helps to keep your financial reports and tax filings correct.
Some common expense categories are:
Operating Expenses - Costs required to run your business day to day (Rent/Utilities)
Payroll and Contractor Costs - Payments made to employees and independent contractors.
Cost of Goods Sold (COGS) - Applies to selling products. These are costs related to producing or purchasing what is sold. (Inventory/Packaging/Shipping)
Marketing and Advertising - Expenses related to promoting the business. (Ads/Email marketing)
Office and Supplies - Office supplies like paper, ink, and postage.
Professional Services - Fees that are paid out to accountants, tax preparers, bookkeepers, attorneys or consultants.
Travel and Meals - Business related travel expenses such as flights, hotels, rentals, and meals.
(Keep these receipts!)
Profit (Net Income)
How Profit is Calculated
Profit is what’s left over after your business pays all of its bills and is calculated like this:
Profit = Revenue – Expenses
Revenue is the money that is earned from selling products or services, and expenses are the costs for daily operation of the business. If you take in more money than you spend, any extra is considered profit. However, if expenses are higher than revenue, you’re operating at a loss.
Using this simple equation, you can determine very quickly if your business is making money and ultimately if you can continue to operate the business in the near future.
Gross vs Net Profit
Not all profits are the same. When reviewing your financial reports, you’ll usually see two types of profit: gross profit and net profit.
Gross Profit
Gross profit is how much money your business takes after covering the direct costs of delivering your product or service.
Gross Profit = Revenue – Cost of Goods Sold (COGS)
Gross profit helps you determine whether or not your products and services are priced properly. If gross profit is too low, it may mean that your costs are high—or that pricing needs readjustment.
Net Profit (Bottom Line)
Net profit, often called the bottom line, shows what’s left after all expenses have been paid
Net Profit = Revenue – All Expenses
Net profit gives you the clearest picture of your overall financial health because it reflects the full cost of running your business and how sustainable it really is.
Conclusion
Having a solid understanding of bookkeeping terms like revenue, expenses, and profit is the first step to knowing the ins and outs of your business. These concepts are the foundation for your financial reports and show you exactly where money is going and how it is earned and spent. When these terms make sense, all your financial reports will become an invaluable tool to help you make informed decisions.
This is just the start of a 3-part blog post on Bookkeeping Terms Every Business Owner Should Know. In Part 2, we’ll continue to break down more essential bookkeeping terms so you can be even more confident reading your reports and planning for growth. If you want help making sense of your financial reports now or need support keeping your books accurate and up to date, reach out today to schedule a consultation or follow along for the next post in this series.
