Is It Important For Business Owners To Understand Accounting Terms?

For non-accounting people, many of the terms accountants use might seem like part of another language, but it is essential that small business owners have some understanding of the more common terms, and what they mean. This enables them to have meaningful conversations with their accountants, which can trigger ideas that could improve their businesses.

Understanding Terminology Makes for Easier Conversations

As accountants and business advisors, we offer services to our clients that are additional to preparing tax returns. It is here that our conversations are made easier when the clients understand the terminology. Our goal at Carbon Group is as much about building the businesses of our clients as it is about our own success.

Of course, there are many terms used in business accounting, but the ones we find most useful in discussions with our clients are:

• Cost of Goods Sold – As its name suggests, this is the cost of purchasing goods from suppliers, including any costs incurred to get them into inventory and ready for sale to the customer. It does not include selling, administration and finance costs.
• Gross Profit Margin – An important calculation; it is the difference between the selling price and the revenue received. Expressed as a percentage, it shows how much profit there is in each sales dollar.
• Operating Profit Margin – This includes expenses not included in the cost of goods sold, such as administration and other costs incurred as part of doing business. It is deducted from sales revenue and converted to a percentage.

New Information can be a Wake-up Call

Sometimes with our new clients, we find that this is the first time this information has been presented to them. In some cases, it shows them why the business is not doing as well as they thought. Carbon Group offers a business health check that focuses on concepts like current ratio, quick ratio and debt to equity.

Turnover is another area that business owners must capture accurately and monitor regularly. In simple terms, to stay in business the owner must generate sales and then collect the money. Neglecting this end of the business can cause solvency problems.

Important terms here are:

• Inventory Turnover: – This calculation shows the number of times a year the inventory, that is, the goods available to be sold, turns over and generates revenue. It is a good indicator of the cash flow position of a business.
• Accounts Receivable Turnover: – Regardless of how much cash is generated, if it is not collected, the business will fold. This ratio tells a business how often it is turning over its debtors’ ledger and also assists with monitoring cash flow and indicating if clients are under pressure.

There are other important concepts owners could know but the value of all these business accounting terms lies in the objective way they report on the state of the business. This allows the owners to take any necessary corrective action.