30 Key Financial Accounting Terminology You Should Know

Here are 30 key financial accounting terms listed alphabetically that every finance professional should know. These top 30 terms cover key methods, processes, and elements of accounting that are essential foundations to your accounting knowledge.  

1. Accrual Accounting

Accrual accounting is a methodology which records revenues and expenses when they are incurred, regardless of when cash is exchanged. An alternative to this would be cash basis accounting, which is when payments and sales are recorded when the cash is exchanged.

2. Accounts Payable

Accounts payable is money a company owes to suppliers for goods or services purchased on credit. It is recorded as a liability on the balance sheet and is usually short term. This forms part of the company operating cash flow so good management of accounts payable would help improve liquidity.

3. Accounts Receivable

Accounts receivable is money owed to a company by customers for goods or services delivered on credit, recorded as an asset on the balance sheet. It forms part of a company’s working capital and can be a key component (along with accounts payable) in ensuring the company is well run from a cash flow perspective.

4. Amortization

Amortization is a term that covers two accounting processes: it is the gradual reduction of a debt or asset value over time – such as paying off a home loan. It can also refer to the reduction in value of an intangible asset, similar to how depreciation affects fixed assets.

5. Assets

Assets are resources with economic value owned by an individual or organization. The most obvious assets are tangible assets including property, plants and equipment. There are also intangible assets such as patents and intellectual property. An asset is defined as something that will provide a future economic benefit for the individual or firm.

6. Balance Sheet

The balance sheet is one of the three core financial statements used in company accounting. It is essentially a list of the assets, liabilities and equity at the end of the most current and previous reporting periods. It is built on the fundamental accounting equation (assets equal liabilities and equity) and provides the structural integrity for the financial statements.

Balance sheets are a snapshot of what a company owns at a specific date in time, usually the end of an accounting period. It details the assets owned or owed to the firm – split by short term (under a year) and long term (over a year). The liabilities detail what the company owes to others, such as debt or leases, as well as the shareholder’s equity.

7. Cash Accounting

Cash accounting is an accounting method that records revenues and expenses when they are actually received or paid, rather than when they are incurred. An alternative to cash accounting would be accrual accounting.

8. Cash Flow Statement

The cash flow statement is one of the key financial statements a company needs to prepare in line with US GAAP and IFRS. It presents the cash flows for the designated period and it reconciles to the cash and cash equivalents number on the balance sheet.

Cash flow statements are useful as they show the inflows and outflows of cash through a company. This is split into operating activities (the core of the business), investment activities and also financing activities. Investors will look closely at a company’s cash flow to ensure it generates enough cash to meet its current and future obligations.

9. Cost Of Goods Sold (COGS)

Cost of goods sold (COGS) are costs that are directly related to the manufacturing and distribution of products. This typically includes raw materials, inventory and other costs of production such as labor and plant costs. COGS do not include indirect costs, such as the marketing or distribution of products.

10. Depreciation

Depreciation is a non-cash expense, and it represents the consumption of benefits of a tangible asset over time. Companies that own certain assets, such as plants and equipment, need to record the amount that it may lose value over time until the end of the asset life.

Depreciation is calculated by estimating a salvage or end-of-life value for the asset and subtracting it from the purchase price. Once a lifetime

11. Dividends

Dividends are payments that companies or funds make as a way of returning earnings to their shareholders. Not all companies pay dividends – usually it is companies which have established consistent annual earnings and have already fully invested in growth in the company.

Dividend policies are usually decided by the management team and approved by the board of directors. Dividends are typically paid out quarterly for listed companies but can also be annually. A special dividend refers to a one-off payment which may be linked to a specific event such as an asset sale or some kind of M&A.

12. Earnings Before Interest and Taxes (EBIT)

Earnings before interest and taxes (EBIT) shows how profitable the company is from its operations. It does not include expenses related to taxes and capital structure, such as interest and tax expenses.

EBIT can be calculated by taking net income and adding back any financing costs or gains as well as taxation for the period. It is similar to operating profit but includes non-operating expenses.

It is useful as a measure of the company’s financial performance before the impact of tax and interest costs which are not directly related to the operations of the company. It is often used by investors in ratios such as EBIT margin or EV/EBIT to compare companies’ financial performance.

13. Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA)

Earnings before interest, tax, depreciation and amortization (EBITDA) is a measure of a company’s overall financial performance. It is used to evaluate a company’s operating performance without having to factor in financing decisions, accounting decisions, or tax environments.

This is also a key number that analysts and investors will use in ratios to gauge the performance of a company relative to peers. EBITDA removes the impact of any financial or accounting decisions (such as depreciation policies) as well as tax and finance expenses.

14. Equity

Equity is the ownership value held by shareholders in a company. It is calculated as the difference between the total assets and total liabilities of the company.

If a company was worth $3m and had net debt of $2m the equity in the company equity would be worth $1m.

Shareholders’ equity represents the difference between a company’s assets and liabilities. A positive shareholders’ equity would infer the company has greater assets than its liabilities.

15. Financing Activities

Financing activities are cash flows related to borrowing and repaying debt as well as issuing and repurchasing stock and paying dividends.

This is a sub-section on the cash flow statement and will show the cash inflows and outflows of how a company funds its operations and growth. It is useful to investors as it shows how a company is managing its capital structure – it may be undertaking a large amount of loans or be reaching a point where it has very little debt to repay.

16. GAAP

GAAP stands for Generally Accepted Accounting Principles and is a set of accounting standards used to prepare financial statements. In the US, any listed company financial disclosures must comply with these accounting standards. In the UK firms can choose to adopt GAAP or IFRS accounting frameworks.

17. Gross Margins

Gross margins are the difference between revenue and cost of goods sold, expressed as a percentage. Gross margins will typically shed light on the costs of production at a company.

If a gross margin is increasing (e.g. from 46.7% to 48.2%) it will suggest that costs are increasing at a slower rate than the sales growth. Conversely if raw material costs spike (e.g. oil and oil derivative prices) then the gross margin will be expected to fall as costs account for a larger proportion of the revenue generated.

18. Gross Profit

Gross Profit is revenue minus the cost of goods sold. This is typically the earliest measure of profitability on an income statement as it looks at profit after COGS have been subtracted. Once other non-operating costs have been included it will become operating profit for the company.

19. Income Statement

The income statement is a financial report showing revenues, expenses, and profit over a period. It is one of the three core financial statements and will typically cover a period such as a year or a quarter and disclose the sales and associated expenses for that period.

It is also known as the Profit and Loss Statement (or P&L statement) and provides investors with an insight into the company’s operations, sales growth and other metrics.

Revenue is usually the ‘top line’ of an income statement, and then costs are stated such as COGS, non-operating expenses, financing costs and tax to end up with net profit, also known as the ‘bottom line’.

20. Inventory

A company’s inventory is typically the materials that are used in the production process. These can be categorized into raw materials, work-in-progress and finished goods.

Controlling this stock is a critical part of company operations and will be a key factor in working capital management. Ideally a company will produce enough stock to meet the demands of all their existing and new customers. However, it will not produce a surplus which will then tie up cash which could have been used elsewhere in the business.

21. Investing Activities

Investing activities are cash flows related to the acquisition and disposal of long-term assets. These are typically displayed below the operating activities of a company on the cash flow statement.

Examples of investing activities include the purchase of new plants or equipment as part of a capex project, or the sale of assets. It can also include investments in securities or other uses of cash whilst investing activities are being undertaken.

22. Liabilities

Liabilities are obligations or debts that a company owes to others. These are recorded on the balance sheet and organised by current (under one year) and non-current (over one year) liabilities. Assets and Liabilities together form a company balance sheet.

23. Liquidity

Liquidity is the ease with which assets can be converted into cash. Highly liquid assets are typically cash or marketable securities, which can be quickly converting into cash when needed. Less liquid assets include property or investments which are privately held, not regularly traded and harder to determine a value for.

24. Net Profit

Net profit (or net income) is the amount by which revenue exceeds expenses and is known as the ‘bottom line’ of the income statement. This is the profit that is remaining after all the operating expenses are paid, as well as financing costs and any tax payable for the period.

Net profit is often used by investors in ratios such as the net margin (net profit/sales) or the PE ratio (price/net profit) to determine the financial health of the company. Early-stage companies may not generate any net profit in the first few years of incorporation, whereas mature companies should have an established infrastructure and be able to generate consistent net profit for its shareholders.

25. Operating Activities

Operating activities are cash flows related to the core operations of the business. These activities form the first section on the cash flow statement and will detail the cash activities in relation to the direct production and sale of the company’s core products or services.

Examples of operating activities includes the receipt of cash from sales, payments for materials and other items from suppliers, manufacturing salary costs and any tax payments associated with the accounting period.

26. Retained Earnings

Retained earnings (RE) are the cumulative net income that has not been paid out as dividends but instead has been reinvested or held within in the business. It is shown on the balance sheet within shareholders’ equity.

27. Revenue

Revenue is the income a company generates before any expenses or costs are deducted. Often called the ‘top line’ or ‘sales’, revenue typically appears as the first item on a company’s income statement.

Revenue records the total income from the sales of the company’s products or services and often investors are keen to look at the growth rate of revenue to ensure that a company is in good financial health. Once expenses are recorded, the remaining income then becomes profit for the company.

Shareholders’ equity is the residual interest in a company’s assets after deducting liabilities. It is essentially the net worth of the company and is shown on the balance sheet after assets and liabilities. It includes any annual retained earnings of the company which have not been returned to shareholders via dividends etc.

If a company was liquidated the shareholder’s equity would the amount available to the shareholders after all the company debts and obligations had been paid. Positive shareholders’ equity suggests that the company has enough assets to cover all of its liabilities.

28. Solvency

Solvency is a term used to define a company’s ability to meet its long-term financial obligations and continue its operations in the foreseeable future. It indicates the financial health of a company and its capacity to pay off its debts as they come due.

A solvent company would generate plenty of cash to ensure it can pay its short-term as well as longer-term financial operations. Investors look keenly at companies to ensure that this solvency is not eroded by external events, or by poor management. If a company was unable to meet its obligations it would become insolvent.

29. Working Capital

Working Capital is a measure of a business’ short-term liquidity and determines how well a company is able to cover the payment of its forthcoming liabilities. It is calculated as current assets minus current liabilities and is a good indicator of a company’s short-term financial health.

In essence it covers the finances that are tied up in the day-to-day operations of the company, such as buying inventory or other items from suppliers, holding stock, and then being paid by customers for the goods or services purchased.

Conclusion

Getting to grips with accounting terminology is a key first step towards a career in the finance world. Download the free Financial Edge resume template to start honing your skills and experience towards catching the eye of a recruitment team