Every morning, Elle Liu, founder of the sustainable bedding company Eucalypso, checks her email—and then she checks QuickBooks. At a glance, she reviews the prior day’s expenses and revenue. “I feel like I could be an accountant myself,” she says on an episode of the Shopify Masters podcast, reflecting on all the accounting terms she’s picked up while building her business. 

Knowing the key markers of your company’s financial health empowers you to make informed decisions. This includes having a grasp of basic accounting terms, some of which can seem complicated at first. Breaking them down into categories—balance sheet, income statement, and general accounting—can make it easier. Let’s jump in and explore the accounting terms you should know.

Balance sheet terms

• Accounts receivable
• Inventory
• Accounts payable
• Accrued expense
• Working capital
• Fixed assets
• Intangible assets
• Net assets
• Equity accounts

The balance sheet shows your company’s financial position at any given point in time. It’s built on the fundamental formula:

Assets = Liabilities + Owner’s equity

This financial statement helps you understand what the business owns, what it owes, and how much is invested by the owners. Here are the key terms that appear on the balance sheet:

1. Accounts receivable

Accounts receivable is money owed to your business by customers for goods or services they have received but not yet paid for. It’s a critical part of cash flow management because a high accounts receivable balance can strain cash flow, even if the business is profitable. Establishing a solid invoicing and collections process can ensure you get paid on time.

2. Inventory

Inventory is an asset representing the goods and materials that a business holds for resale. For a retailer, this is the merchandise on the shelves or in a warehouse; for a manufacturer, it includes raw materials, finished goods, and works in progress. Inventory value is a key component of total assets and directly affects cost of goods sold (COGS) on the income statement.

3. Accounts payable

Accounts payable is the money owed by your business to suppliers and vendors for products or services received on credit. A form of financial obligation, it’s listed as a liability on the balance sheet. Efficient accounts payable management helps you maintain good vendor relationships and control working capital.

4. Accrued expense

An accrued expense is an expense the business has incurred but not yet paid. For example, salaries earned by employees at the end of the accounting period but not yet paid are considered accrued expenses. This is a key part of accrual accounting, where expenses are recorded in the period they are incurred, not when cash is actually paid out.

5. Working capital

Working capital is the difference between a company’s current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable), typically obligations due in a year or less. It’s a liquidity measure, showing your ability to cover short-term obligations and fund operations. Positive working capital means you can pay your bills and invest in growth, while negative working capital may indicate cash flow problems.

6. Fixed assets

Fixed assets, also called property, plant, and equipment (PP&E), are long-term tangible assets a company owns and uses in its business operations to generate income. Examples include buildings, machinery, and vehicles, which are not intended for sale and are expected to provide economic value for multiple accounting periods.

7. Intangible assets

An intangible asset is a non-physical asset that has an economic value for the business. Examples include copyrights, patents, intellectual property, and trademarks. Goodwill (extra monetary value exceeding a company’s net book value) is also considered an intangible asset.

8. Net assets

Net assets is the value of a company’s total assets minus its total liabilities. This figure represents the true worth (or book value) of a business. On a balance sheet, net assets always equal total equity, including owner’s equity and retained earnings. It shows how much of the company’s value is held by investors and owners after debts are paid.

9. Equity accounts

Equity accounts represent the ownership a business has in its assets after all liabilities have been paid. This includes owner’s equity (for a sole proprietorship) or company stock (for a corporation). Other equity accounts include preferred stock, capital gain, and retained earnings. These accounts increase with profits and new investment and decrease with losses and distributions or dividends paid to owners.

Income statement terms

• Net sales
• Revenue recognition
• Cost of goods sold (COGS)
• Gross profit
• Variable costs
• Fixed costs
• Net income (or net profit)

The income statement, also called the profit and loss (P&L) statement, reports a company’s financial performance over a specific period. It focuses on revenues and expenses to show net income (or net profit), providing a look into a business’s profitability.

10. Net sales

Net sales represents the total revenue a company receives from sales, minus any returns, allowances, and discounts. It can be considered a more accurate measure of a company’s sales performance than gross sales, which doesn’t account for these deductions.

11. Revenue recognition

Revenue recognition is a principle of accrual accounting, which requires that revenue is recorded in the period in which it is earned, no matter when the cash is received. For example, if a client is invoiced in December for a service provided, the revenue is recognized in December, even if payment isn’t received until January. Recording revenue in the correct period ensures that it aligns with the related cost of goods sold and operating expenses, giving a true picture of profitability.

12. Cost of goods sold (COGS)

Cost of goods sold includes all direct costs associated with the production of goods (for service-based businesses, it’s sometimes called cost of revenue). For a retailer, this is the wholesale cost of merchandise; for a manufacturer, it includes direct labor and raw materials. Because revenue recognition determines when sales are counted, COGS must also be recorded in the same period to accurately calculate gross profit.

13. Gross profit

Gross profit is a key indicator of a company’s production efficiency, calculated as net sales minus cost of goods sold. It shows a company’s profit before factoring in operating expenses like rent, marketing, and utilities. A strong gross margin (gross profit as a percentage of net sales) indicates a healthy core business.

14. Variable costs

Variable costs are business expenses that change in proportion to the sales volume or output of the business. Raw materials and shipping expenses are variable costs because they increase as you produce and sell more goods. It’s important to keep an eye on variable costs to ensure they don’t get out of control as your business grows.

15. Fixed costs

This type of business expense remains constant, regardless of the level of goods produced or services provided. Examples include insurance, rent, and permanent staff salaries. Fixed costs often contribute a significant amount to a company’s overhead expenses. Understanding fixed costs helps with establishing prices and determining the break-even point of your business.

16. Net income (or net profit)

The final figure on the income statement, net income, represents a company’s total earnings, also referred to as profit after tax or net profit (or, in some cases, net loss). It is calculated by deducting all expenses—including overhead costs, taxes, and interest—from net sales. This is the figure that indicates your business’s true profitability.

General terms

• Accounting cycle
• Accounting principles
• Cash equivalents
• Cash flow
• Certified public accountant (CPA)
• Debits and credits
• Double-entry bookkeeping
• Debt financing and equity financing
• Enrolled agent (EA)
• Financial statement
• Financial transactions
• General ledger
• Journal entry
• Overhead
• Payroll
• Receipts
• Trial balance

These are broad terms that relate to both the financial statements covered above and other aspects of business accounting. They will help you understand the overall context of your financial records.

17. Accounting cycle

A series of steps businesses follow to process their financial information, the accounting cycle begins with business transactions and ends with a trial balance, bank reconciliation, and financial statements. It’s a process that ensures all of the financial transactions are captured, classified, and summarized properly.

18. Accounting principles

Accounting principles are the rules and guidelines companies must follow when reporting their financial data. In the US, the generally accepted accounting principles (GAAP) are the standard, overseen by the Financial Accounting Standards Board (FASB). These principles, which companies with publicly traded stock must follow, ensure consistency in financial statement reporting.

19. Cash equivalents

Cash equivalents are highly liquid financial assets, such as Treasury bills and money market funds, that are readily convertible to cash and have a short maturity, typically 90 days or less. They are a component of the cash flow statement and represent the most liquid resources a business has.

20. Cash flow

This is the net amount of cash and cash equivalents flowing into and out of a business. The cash flow statement tracks all of these movements. It is an indicator of a company’s ability to pay its bills, fund business operations, and make investments in future growth. There are multiple types of cash flow, including operating cash flow (from ordinary business operations), investing cash flow (from investment-related activities), and financing cash flow (from financing activities such as loans or equity issuance).

21. Certified public accountant (CPA)

A certified public accountant is a licensed professional who offers a wide range of financial services. A CPA can help with everything from preparing a business’s income tax returns to providing strategic advice. CPAs are well-versed in tax law and can often be relied upon as trusted advisers for business owners.

22. Debits and credits

Debits and credits are the two entries used in double-entry bookkeeping. Debits increase assets or expenses, and credits increase liabilities or equity. For every journal entry, total debits must equal total credits.

23. Double-entry bookkeeping

Double-entry bookkeeping is an accounting method where every accounting entry is recorded with an equal debit and credit amount. This creates a self-balancing system that helps prevent errors. Many small businesses begin with single-entry bookkeeping before transitioning to the more robust double-entry method. 

24. Debt financing and equity financing

Debt financing is when a business borrows money from an external source, creating a financial obligation that must be repaid with interest. This is a common way to raise capital for business operations. Equity financing is the process of raising capital by selling shares of a company’s stock to investors, who then have an ownership stake. A common form of equity financing for startups is convertible debt, which can later be exchanged for equity at a preset price.

25. Enrolled agent (EA)

An EA is a tax professional authorized to represent taxpayers in dealings with the Internal Revenue Service (IRS). Unlike a CPA, who may provide a wide range of financial services, an EA specializes in tax law and can represent any taxpayer for any tax matter.

26. Financial statement

A financial statement is a formal record of your business’s financial activities and financial position. The three primary statements—balance sheet, profit and loss (or income statement), and cash flow statement—give an overview of a company’s performance and health.

27. Financial transactions

Financial transactions are events that affect the financial position of a business, such as purchases, sales, and payments. Every transaction must be accurately recorded following the rules of double-entry bookkeeping.

28. General ledger

The general ledger is the master record of a company’s financial transactions. It contains all the journal entry records and is organized by account type (e.g., cash, accounts receivable, sales revenue). The general ledger is the foundation from which all other financial statements are created.

29. Journal entry

The first step in the accounting cycle, a journal entry is the record of a business transaction in the company’s accounting books. Each journal entry is dated and includes at least one debit and one credit to ensure the entry is balanced and follows the principles of double-entry bookkeeping.

30. Overhead

Overhead refers to the ongoing costs of operating a business not directly tied to a specific product or service, such as rent and permanent staff salaries. Overhead is often categorized as either fixed costs or variable costs and is a significant portion of a company’s administrative costs.

31. Payroll

Payroll is the total compensation paid to employees for their work during a specific period, including wages, taxes, and benefits. Payroll is a major overhead cost and must be managed carefully, including the deduction of income tax and other mandatory withholdings.

32. Receipts

Receipts are written acknowledgements that a specific article or sum of money has been received. They serve as primary source documents for business transactions. All business receipts should be kept as part of the financial records to support expense claims and other accounting entries.

33. Trial balance

A trial balance is a report prepared at the end of an accounting period that lists the balances of all the accounts in the general ledger. The purpose is to verify that the total debit balances equal the total credit balances. If they don’t, an error has occurred in a journal entry or a subsequent posting, and the mistake must be found and corrected.