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The Five Accounting Terms You Need to Know to Stay in Business

If you want to be successful in business, it helps to know math. And if you know math, it helps even more to know accounting.

Accounting is the backbone of your business, whether it’s a healthcare practice or a small company on the side. It is the circulatory system and heart of every business, regardless of its size.  Yes, you’re passionate and hard-working and excited to be your own boss. But none of this can continue if you can’t show a profit. Knowing whether or not you’re making a profit will help you stay in business.

No one says you have to be a certified public accountant or a numbers guru. But there are some accounting terms that you will need to be very familiar with—not just for when you’re talking to your accountant, but to truly understand your day to day operations.

So please: be very familiar with these.

Balance Sheet.  This is a snapshot of your business at one time. It will show the balances of cash, who owes you money, who you owe money to, and what’s left over (that’s your equity in the business). It’s immediately out of date just one day later. But, assuming it’s relatively current, it’s a great way to measure your financial position.  Potential lenders love this information because it tells them what they can use as collateral and it also gives a good idea of your company’s net worth. Make sure your balances are compared to a “snapshot” from some period before so you know if you’re making progress.

P&L.  This is your profit and loss or income statement.  It’s for a range of dates (i.e. a month, quarter, year) that will tell you, in effect, how much money you’re making (or losing) during that period. It will show revenues and expenses and any other items that affect your profitability and yes, lenders will look closely at this too.  But not as close as you think – because remember: you’re only as good as the last thing you’ve done and a P&L shows history, not the future. But hopefully, and like the balance sheet, you’ll have the current period compared to a prior period—like the same period last year—so you can see if you’re doing better or worse.

General Ledger.  The general ledger is the diary of your business.  It is the foundation for which all other reports – including your balance sheet and profit and loss comes from.  All financial transactions run through this ledger and I mean everything – invoices, bills, payments, receipts, etc.). My best clients print this thing out every month and read through it, making notes and asking questions.  Why? Because the devil’s in the details and your general ledger has all the details. If you’re completely familiar with all the transactions running through your general ledger then you’ve got a good handle on your business operations.  That will come in handy in case anyone asks you about your business.

Accrual Method.  Ever wonder why your accountant is saying you made money but you don’t have anything in the bank to show for it? It’s not such a mystery.   You’re probably on the accrual method of accounting – the main accounting principle that drives the financial statements of most companies (except very small businesses with less than $1 million in revenue—see below). When you’re on the accrual method it means that you’re recording sales when they’ve been invoiced (or incurred) and doing the same with expenses.  So, think about it: say you had one big sale on the last day of the year. You’d be showing a big profit under the accrual method.  But unless you collected on that invoice the same day you won’t have any cash in the bank to show for it. That’s why you have a difference between what’s in the bank and what’s on paper. Which brings me to…

Cash Method. For tax purposes, if your company’s average revenue for the last three years is less than $1 million, then you’re probably allowed to report on the cash method.  It’s the easiest way to do accounting and—because most small businesses in America are very small—it’s also the most popular. When you’re using the cash method it’s all about…well…cash. You record revenues when you collect the cash and record expenses when you disburse cash.  You don’t “accrue” for amounts you owe or are owed.  The problem with this method—as compared to the accrual method—is that it doesn’t tell you (or the reader of your financial statements) about any potential liabilities you owe—or stuff in the future that’s owed to you—and that’s important information to know if someone’s thinking of lending you money.

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I get it—you’re not an accountant. Take it from me, a CPA, that’s probably a good thing. But it’s a bad thing to ignore certain key accounting terms and principles when running your own business.  Like it or not, you’ll never be able to avoid accounting, so you better understand that fact now if you want to grow your company—or get financing—in the months and years ahead.

This article is the point of view of Gene Marks and does not represent the opinion of Bankers Healthcare Group.

Gene Marks

Gene Marks is a columnist, author, CPA and small business expert. He writes daily for The Washington Post newspaper and weekly for Forbes, The Huffington Post website, Inc., Entrepreneur.com, Fox Business and Philadelphia Magazine. He also frequently appears on Fox News, MSNBC and CNBC discussing matters affecting the business community.

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