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Understanding Basic Accounting Terms

Getting your head around basic accounting terms is fundamental for any founder when setting up their startup. At first glance, this task may seem daunting. But by familiarising yourself with some basic terms, you’ll soon be able to decode the secret language of the Accounting world.


Though you won’t have to manage Accounts yourself in the long run, it’s always best to know how to ‘talk the talk’ when it comes to finances. In this blog, we’ll be introducing you to 9 terms guaranteed to pop up when dealing with Accounting services.


1. Overheads


Overheads are costs necessary to your business operation that aren’t directly related to the product or service you provide. Essentially, overheads keep the cogs of your business vehicle turning, whilst you’re behind the wheel.

Your overheads will appear on your profit and loss statement. They’re not related to gross profit, but they do affect profits overall. Lower overheads equal greater profits!

Overhead costs also affect taxes. As they’re allowable expenses, they reduce your profit, therefore lowering your taxes.


There are three types of overhead cost:


· Fixed costs – fixed monthly costs.

· Variable costs – regular recurrent costs that fluctuate over time.

· Semi-variable costs – falling between the two, semi-variables are generally predictable monthly payments, but may change if you exceed a limit.


Examples:


· Employee salaries

· Office Rent

· Business insurance

· Utility bills

· Administrative costs

· Cleaning and maintenance



2. Accounts Payable


Accounts payable (AP) refers to the amount of money a business owes to creditors, such as suppliers, in return for the goods or services they have delivered.


Examples:


· Raw materials/Power

· Transportation and logistics

· Assembling and Subcontracting

· Equipment

· Licensing


If a manufacturing company needs raw materials to complete their production, these items are purchased on credit with a credit period typically upwards of 30 days. Until the payment is made, the suppliers of raw materials will appear as Accounts payable.


3. Accounts Receivable


Accounts receivable (AR) is the inverse of AP – instead of money owed, it represents money that is due to be received. Accounts receivable occur when a company lets a buyer purchase their goods or services on credit.


Examples of AR are just the same as that of AP, just from the viewpoint of the provider.



4. Corporation Tax

Corporation tax is paid by businesses in the UK and is calculated on their annual profits. Since April 2016, the corporation tax rate has been 19% for all limited companies. Prior to this, the rate varied depending on the company's profits. Businesses don't receive any kind of tax-free allowance, meaning that all profits are taxable.


That being said, there are a few expenses and deductions that can be claimed to reduce your bill, such as paying HMRC early or filing an Research & Development (R&D) Tax Credit. An R&D Tax Credit is a government incentive offering tax relief to those using tech to innovate new products or services. Both loss-making and profit-making businesses can file for the R&D Tax Credit Scheme!



5. VAT Returns

Value Added Tax or ‘VAT’ is a tax that’s based on the value of goods or services. If a business is registered for VAT, then it must charge VAT on all its taxable sales.


A VAT return is a form that VAT registered businesses file with HMRC, usually four times a year, to show how much VAT you’re due to pay them.


The payable amount is calculated from the VAT return by subtracting the amount of VAT reclaimable on purchases from the VAT due on sales. If the amount reclaimable on purchases exceeds the amount due on sales, you can reclaim the difference from HMRC.



6. Cashflow

Cashflow simply refers to the movement of money in and out of a company. A company's cashflow is typically determined by operations, investing and financing.


It’s broken down into two categories; inflows (cash coming in) and outflows (money spent).

Let’s think more about what could contribute to your inflows and outflows.


Examples of inflows:


· Proceeds from sales of goods/services

· Returns on investments (ROI)

· Financial activities

· Interest built over time


Examples of outflows:


· Operating expenses

· Liabilities

· Debts

· Annual interest rates

· Wholesale funding


The cashflow statement is a financial statement that reports on a company's sources and usage of cash over a specified time period.



7. Balance Sheet

A balance sheet reports a company's assets, liabilities, and shareholder equity at a specific point in time. Balance sheets allow for the calculation of rates of return for investors, and the evaluation of a company's capital structure.


Put simply, the balance sheet is a financial statement that offers insight into what a company owns and owes, as well as the amount invested by shareholders.


The balance sheet gets its name from the fact that the assets should equal the liabilities and shareholder equity. The equation should be balanced in this way:


Assets = Liabilities + Shareholder Equity


If your balance sheet isn’t compatible with this formula, there’s a chance you’re dealing with misplaced data, miscalculations, or other issues.



8. Opening and Closing Balances

Featured on the balance sheet, opening and closing balances represent your finances at the beginning and end of the month. The opening balance is the amount of cash you start the month with, and the closing balance is the amount of cash you have at the end.


The closing balance follows a formula of:


Closing Balance = Opening Balance + Total of Income - Total of Expenditure


Many early-stage business’ will report a negative closing balance until their income outweighs their spending. If you decide to switch from one accounting system to another, your opening and closing balances provide the basis for accurately starting new records.



9. Credit Control

Credit control is a business strategy that extends credit to a customer to make a purchase of goods or services seem more appealing.


This strategy delays payment for the customer or breaks the payment up into installments of the full amount, also making it easier for a customer to justify the purchase.


This strategy is effective, even though interest charges will always increase the overall cost to more than what it would’ve been if the customer paid outright.


The benefit for businesses is increased sales which leads to increased profits. However, it’s important to have policy in place whereby credit can’t be offered to the buyers with a poor credit history.




As a founder or entrepreneur, getting to know these terms is a useful entry-point into being able to keep your Accounts in order or liaise with an Accounting professional.


Understanding the basics, however, is just the tip of the iceberg – if you want to see your business scale, you may want to seek support from a professional Accounting service.


The duties of traditional Accountants tend to be limited to bookkeeping. Jump Accounting is here to change that.


Jump Accounting is a unique all-in-one Accounting service designed to help startups achieve their growth potential by offering founders exclusive insight into how they can optimize their cashflow.


Accounting should no longer be a dreaded task. With Jump, you can welcome an Accountant who’s invested in your startup’s future. Get in touch with our experts today!

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