When I was an engineer (and that’s a story for a different day), I thought I was the smartest person in the world. Now, I’m a CPA and I know that I am. Okay, not really, but here’s my point. Even people who are smart, or just think they are, struggle with accounting lingo. CPAs like to flaunt how smart we (think) we are and throw around terms that intimidate our clients.
Since I’m a CPA of a different color, I’m going to share with you some of the most common terms you’ll hear thrown around in your accountant’s office.
Accrued Income/Expenses: This might be one of the more difficult concepts. Business transactions consist of two parts: the promise/agreement and the settlement. I agree to buy something from you and promise to pay. The settlement comes when I pay my bill and cash exchanges hands. Accrual Accounting means you track the promise and agreement on the Income Statement, not the exchange of cash.
Accounts Receivable: You provide a good or perform a service for me. I promise to pay you, but haven’t done so yet (but I will, I promise). It’s represented by your outstanding invoices.
Accounts Payable: This is when you make the promise to pay, but haven’t yet sent the cash (hello?!). This is represented by the stack of bills on your desk.
Chart of Accounts: Flash back to when we all worked on paper and used a filing cabinet. The filling cabinet is your General Ledger, which holds every single transaction you’ve made in your business since day one. The Chart of Accounts is essentially the list of file folders in your filing cabinet. Accountants will often number them to keep them nice and tidy.
Depreciation: This is probably the second-most difficult concept. Basically, this is how you show how an asset declines in value as you use it. Okay, maybe not so difficult! But, of course, there are rules for how this is shown on the Income Statement. That’s a conversation best had over martinis.
Direct Costs: These are specific costs that you would not incur if you were not producing a specific good or service. For example, I normally use Quickbooks Online for my bookkeeping software. I incur a cost (I can’t tell you how much, it’s a secret) when I do your books. It’s a direct cost because I wouldn’t pay Quickbooks if I didn’t have you. It’s important to know these costs because they will help you price your product or service.
Indirect Costs: These are costs that you incur regardless of any specific client. For example: rent, utilities, and some employees. (NOTE: I said some!) I have an employee that works on your books, she is now a direct cost. When she does marketing work, she’s now an indirect cost. No wonder she’s always so confused.
Profit: Okay, this may seem obvious since it’s a term we use SO often. The dictionary definition of profit is defined as, “the difference between the amount earned and the amount spent.” Have you ever looked at your Income Statement, then your bank account, and they’re not equal? That ties back into the agreement/promise discussion above. If you’d like a different way to look at your profit, jump to our Profit First page and download the first five chapters pf Mike Michalowicz’ Profit First.