Hiring an accountant is widely considered best practice for small business owners. But delegating financial analysis and reporting doesn’t mean completely checking out of the process each month or quarter. On the contrary, it’s recommended that business owners work closely with their accountants throughout the year to better understand their financial position and make smart plans for future growth.
Want to increase your accounting knowledge so you can have more informed, insightful discussions with your accountant this quarter?
Start right now, with this list of 6 essential accounting terms for small business owners.
1. Cash Flow
Do you have more cash flowing into your business each month than you pay out to cover costs and expenses? If so, your accountant will conclude that you’re “cash flow positive.” If the opposite is true, your cash flow statement will reveal that you’re “cash flow negative.”
Having excess cash on hand means you’re better equipped to keep up with debt, cover unforeseen expenses, and invest in growth opportunities. Your accountant will generate a cash flow statement each quarter to keep tabs on this key performance indicator.
Additionally, understanding cash flow trends can help you plan for seasonal fluctuations. Many businesses experience periods of high and low cash flow throughout the year, and recognizing these patterns allows for better budgeting and resource allocation. For instance, if your business sees a surge in sales during the holiday season but slows down in the summer, knowing how to manage cash reserves can prevent financial strain.
2. Profit and Loss Statement
The profit and loss statement (also known as the income statement) is one of the most important documents used by accountants to determine the profitability of your business.
The P&L statement lists revenues and gains as well as expenses and losses over a specific period of time (typically every three months for small businesses). It calculates your all-important “bottom line” so you know if you’re operating at a loss or turning a profit.
Regularly reviewing your P&L statement can also help you identify trends in revenue and expenses, enabling you to adjust pricing strategies or cut unnecessary costs. A detailed analysis may reveal underperforming products, excessive overhead, or areas where investment could lead to increased profitability.
3. Gross vs Net Profit
Gross profit is what remains when you subtract the cost of goods sold (COGS) from your total revenue. Net profit, on the other hand, drills deeper. It reveals your exact dollar per profit of sales after subtracting all operating expenses, including COGS, taxes, interest paid on debt, etc.
Gross and net profit are both profitability ratios. They are key for measuring business performance against an industry benchmark and your competitors.
By tracking these figures over time, you can set realistic growth goals and identify cost-saving opportunities. A shrinking gross profit margin may indicate rising production costs, while a declining net profit could suggest inefficiencies in operations, excessive debt, or high fixed expenses.
4. Balance Sheet
The balance sheet offers a snapshot of your overall financial position at a particular moment in time. It lists the assets (such as cash, inventory, accounts receivable, and equipment); liabilities (like accounts payable, income tax, and employee salaries); and shareholder capital. In a nutshell, the balance sheet shows what you own, as well as what you owe.
Business owners should regularly review their balance sheet to assess financial stability and liquidity. A strong balance sheet with healthy assets and manageable liabilities is a key indicator of business health. Lenders and investors often analyze balance sheets before providing funding, so keeping this document in order is crucial for securing loans or attracting investment.
5. Accounts Receivable & Accounts Payable
Simply put, accounts receivable is money your business is owed by customers for goods or services sold. It is considered an asset on your balance sheet. Conversely, accounts payable is money you owe suppliers and any bills you have yet to pay, so it’s listed as a liability on your balance sheet.
Managing these effectively ensures a steady cash flow. If accounts receivable remain unpaid for too long, your business could experience cash shortages. Implementing clear invoicing policies, offering early payment incentives, and following up on overdue invoices can help improve collection rates. On the flip side, strategically managing accounts payable—such as negotiating longer payment terms with suppliers—can help you maintain liquidity.
6. Bad Debt Expenses
Bad debt happens when you can’t collect payment from your customers. Long-term outstanding accounts receivable could be listed on your balance sheet as “bad debts,” and if they’re never collected, may have to be written off as a loss.
To minimize bad debt, businesses should conduct credit checks on new clients, set clear payment terms, and have a structured follow-up system for late payments. Using accounts receivable aging reports can help track overdue payments and take action before debts become uncollectible. In some cases, businesses may also consider working with collection agencies to recover unpaid balances.
And there you have it – six key terms to help you build your accounting vocabulary, join the conversation, and empower smarter decision-making.
