You don’t have to be an accounting expert to run a business—most small business owners aren’t. But you do need to know the basic terms and formulas that accountants use to talk about your business finances.
Understanding these terms and formulas helps you communicate effectively with your finance team, including your accountant or bookkeeper. And knowing these terms gives you more credibility when you speak with investors or other financial professionals.
Plus, as a business owner, you should have a basic understanding of the accounting process—even if you’re not directly overseeing it. You need to know where transactions are recorded, how they’re organized, and how to use that information to determine the financial health of your business.
Understanding these terms and formulas can help you communicate effectively with your finance team, including your accountant or bookkeeper.
Whether you’re a new business owner wearing multiple hats, including that of “bookkeeper,” or an old hand with bookkeepers on staff, these are the financial terms you need to know:
Accounts receivable is the money customers owe your business for products or services that have already been delivered or invoiced. In other words, it’s money you will receive.
Accounts payable is money your business owes to vendors and suppliers for products or services that have already been delivered or invoiced. In other words, it’s money you will pay.
Accruals is a list of expenses you have incurred but not yet paid, or a list of sales that have been completed but not yet billed. The accrual-basis accounting method is a critical component of the generally accepted accounting principles. This method requires recognizing revenues and expenses at the time of sale—rather than when you receive payment.
Allocation is the process of distributing or allocating funds, resources, or costs to a particular account or particular purpose. For example, you might allocate a percentage of your revenue to be used for a big purchase.
Assets are the things your company owns, including equipment, property, cash, tools, copyrights, patents, and trademarks.
A balance sheet is an overview of your company’s financial status. It reports assets, liabilities, and equity at a specific point in time. It’s a snapshot of what your company owns and owes.
Cash flow describes the inflow and outflows of cash in your business, or the movement of money. Cash flow is calculated for a specific point in time. Positive cash flow indicates a business has more money flowing in than out. Negative cash flow means you’re spending more than you’re bringing in.
Depreciation is the process of assets losing value over time. Assets, like equipment and vehicles, slowly depreciate over time, allowing your business to slowly write off the cost of the asset and receive a tax deduction for it each year.
Equity is the portion of a company owned by investors and owners—you. It’s the value of assets left over after liabilities have been subtracted.
Expenses refer to the costs of acquiring something—from tangible items to intangible services. Expenses can be fixed, like salaries and rent, or variable, which can vary from purchase to purchase.
A fiscal year is the one-year period of time you use for accounting purposes. A fiscal year can coincide with the calendar year, but it doesn’t have to. Your fiscal year may run from October to September of the following year.
Forecasting is the process of using your business’s historical financial data to predict future trends, including budgets, sales, profits, cash flow projections, and more. For example, your historical financial data might tell you that sales consistently dip during the summer months. Knowing this, you can better prepare (and brainstorm possible solutions).
The general ledger is a record of your business’s financial transactions over the lifetime of your business. Every transaction, including revenues and expenses, is recorded in the general ledger. It’s a recordkeeping system used to sort, store, and summarize transactions.
Journals, or accounts, record transactions as they occur—before they are transferred to the general ledger. Transactions should be completed and reconciled in the journal before they’re transferred to the official general ledger.
Liabilities are debts that your business is responsible for paying, including things like mortgages, loans, and credit card balances.
Liquidity refers to how quickly an asset can be converted into cash. Cash is an extremely liquid asset while tangible assets are less liquid.
A profit and loss statement, or P&L, lists earnings, expenses, and net profits for a given period of time. A P&L can also be referred to as an income statement. This statement gives you a snapshot of your business’s financial performance and profitability.
Reconciliation is the process of matching the balances in your accounting records to the corresponding balances reported by your financial institution. In layman’s terms, it means matching the transactions in your journal entries to the transactions in your bank account and ensuring they’re consistent.
Revenue is the total amount of money collected for goods and services sold, including any credits or discounts for returned merchandise. Revenue is calculated before subtracting expenses. Subtracting expenses results in your net income.
Working capital is the amount of money your business has to invest or spend on items for the business at a point in time. It’s the difference between your company’s current assets and current liabilities.
There are countless accounting equations you can use to calculate the financial health of your business. But no one expects you to be a mathematician (that’s where your accountant comes in). That being said, there are a few formulas you might want to keep in your back pocket so you can confidently make smart financial decisions for your business. They are:
Net income is the amount your business makes after deducting expenses. If you’re just starting out, it's possible you’ll have a negative net income. However, it should be every business owner's goal to have a positive net income—this indicates that your business is profitable. To calculate net income, subtract business expenses and operating costs from your revenue.
Net income = Revenue - Expenses
Your break-even point tells you how much money you need to make to cover all your costs and expenses and generate a profit of $0. It’s the point at which the costs of running your business equals revenue generated. Every sale over your break-even point means profit for your business. But if you’re spending more than your break-even point, you’re losing money. To calculate the break-even point in sales dollars, divide fixed costs by the contribution margin, or the profit of a single sale.
Break-even point (in dollars) = Fixed costs / Contribution margin
Your profit margin is the percentage of profit you keep from every sale. For example, a 25% profit margin means you earned $0.25 of profit for each dollar of sales generated. A low profit margin might indicate that your prices are too low. But profit margins vary by industry, a low profit margin for one business might be considered high by another. To calculate your profit margin, divide net income by net revenue and multiply by 100.
Profit margin = (Net income / Revenue) X 100
Days sales outstanding is the number of days it takes for your business to collect payment following a sale. A lower days sales outstanding number means you’re collecting payments faster. A higher days sales outstanding means you might be waiting too long to get paid what you’re owed, and it could be impacting your business’s cash flow. To find days sales outstanding, divide accounts receivable by total credit sales and multiply by the number of days in the time period. For example, if you’re calculating days sales outstanding for the month, 31 is the number of days.
Days sales outstanding = (Accounts receivable ÷ Total credit sales) X Number of days
The current ratio, or cash ratio, equation measures your company’s ability to pay off all your debts or liabilities at once, if you need to do so. That hopefully won’t happen, but knowing your cash ratio gives you a good idea as to how much cash or current assets you have on hand at any given time. To find the cash ratio, divide current assets by current liabilities.
Current ratio = Current assets + Current liabilities
Tracking expenses, categorizing transactions, and automating accounting processes is easy when you use QuickBooks Online. QuickBooks syncs with your accounts to automatically track and categorize income and expenses. And when you shop using your Amazon Business account, the Amazon Business Purchases app for QuickBooks is the smart and simple way to review and organize transactions. See product descriptions, costs, and fee breakdowns for every transaction, then categorize and match with your bank transactions automatically.
This app only works with Amazon Business accounts. Sign up for a free Amazon Business account to access of wide selection of products and tools for your business.
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