The language of business money
Five key terms
- Revenue
- Money earned from selling products or services.
- Expenses
- The costs of running the business, such as rent, advertising and supplies.
- Assets
- What the business owns: cash, equipment, inventory and money customers owe it, called accounts receivable.
- Liabilities
- What the business owes: loans, credit card balances and unpaid bills, called accounts payable.
- Equity
- The owner's share of the business: what's left after liabilities are subtracted from assets.
Profit is revenue minus expenses. If expenses are larger, the result is a loss.
The accounting equation
This equation is always true. Everything a business owns was paid for either with borrowed money (liabilities) or with the owner's money and profits (equity). Every transaction keeps it in balance.
Double-entry bookkeeping
Every transaction affects at least two accounts. When a business buys a $600 pressure washer with cash, its equipment goes up by $600 and its cash goes down by $600. Recording both sides is called double-entry bookkeeping, and it makes errors easier to catch.
The two sides are called debits and credits. Debits are recorded on the left and credits on the right. In every transaction, total debits must equal total credits.
| Account type | To increase it | To decrease it |
|---|---|---|
| Assets | Debit | Credit |
| Expenses | Debit | Credit |
| Liabilities | Credit | Debit |
| Equity | Credit | Debit |
| Revenue | Credit | Debit |
Debits increase what the business has and spends: assets and expenses. Credits increase where the money came from: liabilities, equity and revenue.
Cash or accrual?
With cash accounting, you record revenue when money arrives and expenses when you pay them. With accrual accounting, you record revenue when you earn it and expenses when you incur them, even if no money has changed hands yet. Accrual gives a truer picture of performance and is required for many larger businesses. Small businesses can often choose either, so check the rules where you live.
Keep your source documents
Every entry should be backed by a document: a receipt, invoice, bank statement or contract. Tax authorities can ask to see these records years later, so store them safely on paper or as scans.