Basic Accounting Terms Every Beginner Must Know (Complete Guide)
Basic Accounting Terms Every Beginner Must Know
You do not need an accounting degree to understand how money moves in a business. This guide explains every essential accounting term in plain English — no jargon, no confusion. You will follow John Smith as he opens and runs John Textile Store, and every concept will be explained using his real business decisions. By the end, accounting will feel logical, not intimidating. If you are completely new to the subject, start with our introduction to basic accounting before continuing.
Meet John Smith & John Textile Store
Before any definition, meet the business we will use throughout this entire guide. Every accounting term you learn will connect directly to John's story.
John Smith is a 32-year-old entrepreneur who has always wanted to own a business. After years of saving, he opens John Textile Store — a shop that sells fabric, clothing material, and readymade garments. He invests $50,000 of his own money to get started. As his business grows — buying inventory, selling to customers, hiring staff, taking a loan, and eventually preparing financial reports — every accounting term will become clear and connected.
The Accounting Equation: The Foundation of Everything
The accounting equation is Assets = Liabilities + Equity. It is the core rule of double-entry bookkeeping. It states that everything a business owns (assets) is funded either by borrowing (liabilities) or by the owner's own money (equity). This equation must always remain perfectly balanced after every transaction.
Every financial transaction in every business — in every country, in every century — follows one equation:
If you understand only one thing from this guide, make it this equation. Every financial statement, every journal entry, and every ledger account exists purely to keep this equation in balance. Read our dedicated guide on the accounting equation explained with real examples for a full deep-dive.
On Day 1, John deposits his $50,000 savings into the business bank account. His accounting equation immediately is: Assets ($50,000 cash) = Liabilities ($0) + Equity ($50,000). The business has $50,000 in assets, owes nothing to anyone, and $50,000 belongs entirely to John. Balanced perfectly.
Assets always equal liabilities plus equity. If this equation is ever unbalanced, a recording error exists somewhere. Every transaction you ever record must keep this equation balanced.
Assets
An asset is anything of value that a business owns or controls, which is expected to provide a future economic benefit. Assets include cash, inventory, equipment, vehicles, buildings, and money owed by customers. On the balance sheet, assets appear on the left side and are categorized as either current (short-term) or fixed (long-term).
Assets — Simple Definition
An asset is anything the business owns that has monetary value. If you can sell it, use it to earn money, or eventually convert it to cash — it is an asset.
Real-World Explanation: Think of assets as your business's "what we have" list. Cash in your register, fabric stacked on your shelves, the delivery van outside, the shop building you own, and even money your customers have promised to pay you — all of these are assets.
John starts with $50,000 cash. He then makes the following purchases:
- Fabric and garments for resale: $30,000
- Delivery van: $8,000
- Shop shelving and fixtures: $2,000
- Remaining cash: $10,000
Total assets = $50,000. The money changed form — from cash into inventory, a van, and shelving — but the total asset value is still $50,000.
Current Assets vs Fixed Assets
| Current Assets | Fixed Assets (Non-Current) |
|---|---|
| Convertible to cash within one year | Used long-term; not for quick sale |
| Cash in hand or bank | Land & Building |
| Inventory (stock for sale) | Machinery & Equipment |
| Accounts Receivable | Delivery Vehicles |
| Short-term investments | Furniture & Fixtures |
| Prepaid expenses | Computer systems |
| John's example: $10,000 cash + $30,000 inventory | John's example: $8,000 van + $2,000 shelving |
If the business owns it and it has value — it is an asset. Current assets are short-term resources. Fixed assets are long-term tools. Both appear on the balance sheet under the assets section.
Liabilities
A liability is a financial obligation that a business owes to an outside party. Liabilities include bank loans, unpaid supplier invoices, credit card balances, and wages owed to employees. They represent claims that creditors have on the business's assets and are listed on the right side of the balance sheet.
Liabilities — Simple Definition
A liability is a debt the business owes. It is the "what we owe" side of accounting. Every loan, every unpaid bill, every financial obligation is a liability.
Real-World Explanation: When a business borrows from a bank, the loan is a liability. When it buys supplies but has not paid yet, that unpaid amount is also a liability. Liabilities are future payments the business is obligated to make.
Six months in, business is growing but John needs more stock. He takes a $15,000 bank loan to purchase additional fabric. He also receives $5,000 worth of garments from a supplier on credit — he will pay next month. John now has:
- Bank Loan: $15,000 (long-term liability)
- Accounts Payable to supplier: $5,000 (current liability)
- Total Liabilities: $20,000
Current vs Long-Term Liabilities
- Current Liabilities: Due within one year — accounts payable, short-term loans, wages payable, taxes owed.
- Long-Term Liabilities: Due after one year — bank term loans, business mortgage.
| Comparison | Assets | Liabilities |
|---|---|---|
| What they represent | What the business owns | What the business owes |
| Effect on net worth | Increases net worth | Decreases net worth |
| Examples | Cash, inventory, building | Loans, unpaid bills, wages owed |
| Position in equation | Left side (A = L + E) | Right side (A = L + E) |
| Business goal | Grow assets | Minimize liabilities |
Liabilities are what your business owes. High liabilities compared to assets signal financial stress. Low liabilities compared to assets signal financial strength.
Equity & Capital
Equity is the owner's financial stake in the business — what remains after subtracting all liabilities from total assets. It includes the original capital invested, accumulated profits retained in the business, and is reduced by losses or owner withdrawals. Equity is also called owner's equity, net worth, or shareholders' equity in larger companies.
Equity — Simple Definition
Equity = Assets − Liabilities
Equity is what the business is truly worth to its owner after every debt is paid off. It represents the owner's real, residual claim on the business.
Capital — Simple Definition
Capital is the money the owner originally invests to start the business. It is the seed investment that gets operations going.
How Capital Becomes Equity
Capital is the starting point. Equity is the running total. When the business earns profit, equity grows. When it suffers a loss or the owner takes money out (drawings), equity shrinks. Equity is capital adjusted for everything that has happened since opening day.
John invested $50,000 — that is his capital. After Year 1, the business earned a net profit of $8,000. John's equity is now: $50,000 (capital) + $8,000 (profit retained) = $58,000. The business is worth more to John than when he started because it earned more than it spent.
Capital is what you put in on Day 1. Equity is your current ownership value. Profitable business = growing equity. Loss-making business = shrinking equity.
Revenue & Income
Revenue is the total amount of money a business earns from its primary operations — selling goods or services — before deducting any costs. It is also called sales or turnover and appears at the very top of the income statement. Because it sits at the top, revenue is known as the "top line" of the business.
Revenue — Simple Definition
Revenue is the total money earned from selling products or services. It is not profit. It is the grand total customers paid before any costs are subtracted.
Income — Simple Definition
In everyday speech, "income" and "revenue" are used interchangeably. In formal accounting, income can also include money earned outside core operations — such as bank interest, rental income, or investment returns.
In Year 1, John Textile Store sells fabric and garments totaling $95,000. That is John's revenue. Additionally, John earns $800 interest from his business savings account. Total income = $95,800. But John cannot call this his profit yet — he must subtract all his costs first.
| Comparison Point | Revenue | Profit |
|---|---|---|
| Definition | Total money earned from sales | What remains after all costs are deducted |
| Also called | Sales, Turnover, Top Line | Net Income, Bottom Line, Earnings |
| Includes costs? | No — gross total only | Yes — all costs already deducted |
| John's figure | $95,000 | $2,000 (after all deductions) |
| Position on income statement | First line | Last line |
Revenue is what you earn. Profit is what you keep. High revenue with high expenses can still mean a loss. Focus on both, not just one.
Expenses
Expenses are the costs a business incurs to generate revenue and keep operations running. They include rent, wages, electricity, transportation, advertising, and cost of goods sold. Expenses are recorded on the income statement and subtracted from revenue to calculate profit. Higher expenses relative to revenue reduce profit.
Expenses — Simple Definition
An expense is any cost the business pays to operate. Every bill, every salary, every overhead cost is an expense.
To run John Textile Store during Year 1, John pays:
- Shop Rent: $12,000
- Employee Wages (2 staff): $18,000
- Electricity & Utilities: $2,400
- Delivery & Transport: $1,800
- Advertising: $1,200
- Miscellaneous: $600
- Total Operating Expenses: $36,000
Types of Expenses
- Cost of Goods Sold (COGS): Direct cost of products sold — detailed in its own section below.
- Operating Expenses: Rent, salaries, utilities — costs of running the business.
- Financial Expenses: Interest paid on loans.
- Depreciation: The gradual write-down of fixed asset value — detailed below.
Every dollar spent running your business is an expense. The goal is not to eliminate expenses — it is to ensure that every expense generates more revenue than it costs.
Profit, Gross Profit, Net Profit & Loss
Gross profit is revenue minus the cost of goods sold — it measures how efficiently a business produces or procures its products. Net profit is what remains after subtracting all operating expenses, interest, and taxes from gross profit. Net profit is the true "bottom line" — the actual amount the business earned after every cost is accounted for.
Gross Profit
Gross Profit = Revenue − Cost of Goods Sold (COGS)
Gross profit shows how much is left after paying for the products you sold — before rent, wages, or any other running costs.
Net Profit
Net Profit = Gross Profit − All Operating Expenses − Interest − Taxes
Net profit is the real result. It is what the business owner actually earned after every single cost is paid.
Loss
When total expenses exceed total revenue, the result is a net loss. A loss means the business consumed more than it produced during that period.
- Revenue: $95,000
- Less: Cost of Goods Sold (COGS): −$57,000
- = Gross Profit: $38,000
- Less: Operating Expenses: −$36,000
- = Net Profit (before tax): $2,000
It was a tight first year — but John's store made a profit. Year 2 goals: grow revenue and control costs to widen the margin.
| Term | Formula | John's Numbers |
|---|---|---|
| Revenue | Total sales | $95,000 |
| Less: COGS | Cost of products sold | −$57,000 |
| Gross Profit | Revenue − COGS | $38,000 |
| Less: Operating Expenses | All running costs | −$36,000 |
| Net Profit | Gross Profit − Expenses | $2,000 |
Gross profit shows product efficiency. Net profit shows overall business health. Always track both — a business with good gross profit can still fail if its operating expenses are out of control.
Sales & Purchases
Sales — Simple Definition
Sales are transactions where the business transfers goods or services to a customer in exchange for money. Sales generate revenue. Every time a customer buys something from John's store, that is a sale.
Purchases — Simple Definition
Purchases are transactions where the business buys goods from suppliers — typically inventory that will later be resold. Purchases increase inventory and are a component of COGS.
John purchases 500 metres of fabric from a textile supplier for $8,000. Over the following weeks, he sells that fabric to customers for $13,500. The difference between what he sold it for and what he paid for it is the beginning of his profit calculation.
Purchases are costs going out to build your stock. Sales are revenues coming in as customers buy that stock. The gap between the two — after all other costs — determines your profit.
Inventory
Inventory is the stock of goods a business holds for the purpose of selling to customers. In accounting, inventory is classified as a current asset because it is expected to be converted to cash within one year through sales. Inventory is recorded on the balance sheet and is used to calculate the cost of goods sold.
Inventory — Simple Definition
Inventory is everything your business has in stock that is available for sale. For a textile store, it is all the fabric and garments sitting on the shelves waiting for customers.
John starts the year with $30,000 worth of inventory — fabric rolls, garments, and accessories. During the year he spends another $57,000 purchasing more stock as items sell. At year-end, a physical count shows $30,000 of inventory remaining unsold. This ending inventory figure goes on his balance sheet as a current asset.
Inventory Formula
Ending Inventory = Opening Inventory + Purchases − Cost of Goods Sold
Inventory is your stock. It is an asset until the moment it is sold — then it becomes an expense (COGS). Unsold inventory at year-end is still your asset and stays on the balance sheet.
Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) is the direct cost of the products a business sold during a specific period. It includes the purchase price of inventory sold, plus any direct costs of getting the goods ready for sale. COGS is subtracted from revenue to calculate gross profit. It appears on the income statement directly below revenue.
COGS Formula
COGS = Opening Inventory + Purchases − Closing Inventory
- Opening Inventory (start of year): $30,000
- Add: Purchases during the year: +$57,000
- Less: Closing Inventory (end of year): −$30,000
- = Cost of Goods Sold: $57,000
This means John's store consumed $57,000 worth of inventory to generate $95,000 in sales — leaving a gross profit of $38,000.
COGS is the direct cost of the products you sold — not all your business expenses, just the cost of the goods themselves. Lower COGS relative to revenue means better gross profit margins.
Cash, Accounts Receivable & Accounts Payable
Cash — Simple Definition
Cash is money the business has immediately available — physical currency in the register or funds in the business bank account. Cash is the most liquid asset a business possesses.
After his initial purchases, John has $10,000 cash left in the bank. This is his available cash — money he can use immediately to pay expenses, restock inventory, or handle emergencies.
Accounts Receivable — Simple Definition
Accounts receivable (AR) is money owed to the business by customers who have already received goods or services but have not yet paid. It is a current asset because the business expects to collect it within a short period.
A clothing shop owner — a regular customer — buys $3,500 of fabric from John but asks to pay in 30 days. John delivers the goods. That $3,500 is now Accounts Receivable — John has earned the revenue but has not received the cash yet. It sits on his balance sheet as a current asset until the customer pays.
Accounts Payable — Simple Definition
Accounts payable (AP) is money the business owes to suppliers for goods or services already received but not yet paid. It is a current liability.
John receives a shipment of $5,000 of garments from his supplier with payment due in 45 days. John has the goods. He owes the supplier $5,000. That $5,000 is Accounts Payable — a current liability on his balance sheet until he pays it.
| Comparison | Accounts Receivable (AR) | Accounts Payable (AP) |
|---|---|---|
| What it is | Money customers owe you | Money you owe suppliers |
| Type | Current Asset | Current Liability |
| Direction of money | Money coming in (future) | Money going out (future) |
| Created when | You sell on credit | You buy on credit |
| John's example | $3,500 owed by customer | $5,000 owed to supplier |
| Closed when | Customer pays you | You pay the supplier |
AR = people owe you money (your asset). AP = you owe people money (your liability). Managing both effectively is critical to cash flow health.
Working Capital
Working capital is the difference between a business's current assets and its current liabilities. It measures the business's short-term financial health and its ability to pay bills that are due within the next twelve months. Positive working capital means the business can meet its short-term obligations. Negative working capital signals potential liquidity problems.
Working Capital Formula
Working Capital = Current Assets − Current Liabilities
- Current Assets: Cash $10,000 + Inventory $30,000 + AR $3,500 = $43,500
- Current Liabilities: AP $5,000 + Short-term portion of bank loan $3,000 = $8,000
- Working Capital = $43,500 − $8,000 = $35,500
John has strong working capital. He can comfortably pay all his short-term bills with room to spare.
Working capital tells you if a business can survive the next 12 months without running out of money. Positive = financially stable short-term. Negative = danger signal.
Debit & Credit
In accounting, debit and credit are the two sides of every transaction in the double-entry system. Debit (Dr) records on the left side of an account; credit (Cr) records on the right. Debits increase assets and expenses; credits increase liabilities, equity, and revenue. Every transaction has at least one debit and one equal credit, keeping the accounting equation balanced.
The Golden Rule of Debit and Credit
Forget your bank statement's use of "debit" and "credit" — in accounting, these terms have precise meanings based on account type.
| Account Type | Debit Effect | Credit Effect |
|---|---|---|
| Assets | ⬆ Increases | ⬇ Decreases |
| Liabilities | ⬇ Decreases | ⬆ Increases |
| Equity / Capital | ⬇ Decreases | ⬆ Increases |
| Revenue / Income | ⬇ Decreases | ⬆ Increases |
| Expenses | ⬆ Increases | ⬇ Decreases |
John pays $12,000 rent for the year from his bank account. In double-entry bookkeeping:
- Debit Rent Expense $12,000 → Expense increases (debit increases expenses)
- Credit Cash $12,000 → Cash (asset) decreases (credit decreases assets)
Total debits = $12,000. Total credits = $12,000. The accounting equation stays balanced.
Every transaction has two sides — a debit and a credit of equal value. Debits are not always bad and credits are not always good. Their effect depends entirely on the type of account being recorded.
Journal Entry & General Ledger
Journal Entry — Simple Definition
A journal entry is the first formal record of a financial transaction. Every time money moves in or out of the business — or any financial event occurs — it is recorded as a journal entry, showing which accounts are debited and credited.
General Ledger — Simple Definition
The general ledger is the master record that contains all journal entries organized by account. Every account (cash, inventory, rent expense, etc.) has its own page in the ledger. The ledger shows the full history and running balance of every account in the business.
John purchases $8,000 of fabric on cash. The journal entry is:
- Debit: Inventory $8,000 (inventory asset increases)
- Credit: Cash $8,000 (cash asset decreases)
This entry is then posted to two accounts in the General Ledger: the Inventory account (debit side) and the Cash account (credit side). The ledger now reflects that John has $8,000 more inventory and $8,000 less cash.
Journal entries are the raw record of every transaction. The general ledger is where all those entries are organized by account. Journal → Ledger → Trial Balance → Financial Statements. That is the accounting flow.
Trial Balance
A trial balance is a summary list of all general ledger account balances at a specific date. It has two columns — debit balances and credit balances. The total of all debit balances must equal the total of all credit balances. The trial balance is used to verify that the books are mathematically correct before preparing formal financial statements.
Trial Balance — Simple Definition
A trial balance is a checklist that proves your debits equal your credits. It is not a financial statement — it is a verification step that confirms no arithmetic errors exist in the ledger before you prepare the official reports.
At year-end, John's bookkeeper extracts all ledger balances into a trial balance. The total of all debit balances is $153,800. The total of all credit balances is also $153,800. The trial balance agrees — the books are mathematically correct and John can now prepare his financial statements.
A trial balance that balances does not mean your accounts are error-free — it only confirms there are no mathematical errors. Wrong amounts posted to the right accounts will still pass a trial balance check.
Financial Statements: Balance Sheet, Income Statement & Cash Flow
The three core financial statements are the Balance Sheet, the Income Statement, and the Cash Flow Statement. The balance sheet shows what the business owns and owes at a specific date. The income statement shows revenue, expenses, and profit over a period. The cash flow statement tracks actual cash movements — inflows and outflows — over a period.
Balance Sheet
The balance sheet is a snapshot of the business's financial position on a specific date. It lists all assets, all liabilities, and the owner's equity. The fundamental rule: Assets = Liabilities + Equity — and this must balance on every balance sheet, every time.
Assets: Cash $10,000 | Inventory $30,000 | AR $3,500 | Van $8,000 | Shelving $2,000 = Total Assets: $53,500
Liabilities: AP $5,000 | Bank Loan $15,000 = Total Liabilities: $20,000
Equity: Capital $50,000 + Profit $8,000 − Drawings $24,500 = $33,500
Total Liabilities + Equity = $53,500 ✓ Balanced
Income Statement (Profit & Loss Statement)
The income statement shows the business's financial performance over a period of time — usually a month, quarter, or year. It lists revenue at the top, subtracts COGS to arrive at gross profit, then subtracts operating expenses to arrive at net profit or loss.
Cash Flow Statement
The cash flow statement tracks all actual cash that moved in and out of the business during a period. It is divided into three sections: operating activities (day-to-day cash), investing activities (buying/selling assets), and financing activities (loans, equity). A business can be profitable on paper but still run out of cash — the cash flow statement reveals this reality.
John's income statement shows a net profit of $2,000. But his cash flow statement tells a different story: $3,500 is still uncollected from a customer (AR), and he prepaid $1,200 in rent. His actual cash inflow this period was less than his paper profit. Cash flow ≠ profit — and John must manage both.
Balance Sheet = what you own and owe (a moment in time). Income Statement = did you make money (a period). Cash Flow = did you actually collect the cash (a period). All three together give the complete financial picture.
Depreciation
Depreciation is the systematic reduction in the recorded value of a fixed asset over its useful life. It recognizes that assets like vehicles, machinery, and equipment lose value through use and aging. Depreciation is recorded as an expense on the income statement and reduces the asset's value on the balance sheet each year.
Depreciation — Simple Definition
Depreciation is the annual cost of using a fixed asset. A delivery van does not last forever — its value decreases every year it is used. Depreciation spreads that cost over the asset's useful life.
Straight-Line Depreciation Formula
Annual Depreciation = (Cost − Salvage Value) ÷ Useful Life in Years
John's delivery van cost $8,000. He estimates it will last 5 years and have a salvage (scrap) value of $500 at the end. Annual depreciation = ($8,000 − $500) ÷ 5 = $1,500 per year. Each year, John records $1,500 as a depreciation expense — reducing his profit and the van's book value on the balance sheet by $1,500.
Depreciation is not a cash payment — it is an accounting adjustment. It ensures that the cost of using a long-term asset is matched against the revenue that asset helps generate, year by year.
Bookkeeping & Accrual Accounting
Bookkeeping — Simple Definition
Bookkeeping is the process of recording every financial transaction of a business in an organized, systematic way. It is the day-to-day activity of writing down every sale, every purchase, every expense, and every payment — accurately and on time. Bookkeeping is the foundation on which all accounting and financial reporting is built.
Accrual Accounting — Simple Definition
Accrual accounting is a method where revenue is recorded when it is earned — not when cash is received — and expenses are recorded when they are incurred, not when they are paid. This contrasts with cash accounting, which only records transactions when actual cash moves. Accrual accounting gives a more accurate picture of a business's true financial performance.
In December, John sells $3,500 of fabric to a customer who will pay in January. Under cash accounting, this revenue is recorded in January when cash arrives. Under accrual accounting, this revenue is recorded in December when John earned it by delivering the goods. Accrual accounting gives a more accurate picture of December's performance.
Accrual accounting records when you earn and owe, not when cash moves. Most established businesses use accrual accounting because it gives a more accurate, complete financial picture.
Owner Drawings
Owner drawings are amounts of money or assets that the owner withdraws from the business for personal use. Drawings are not an expense — they are a reduction of the owner's equity. They are recorded as a debit to the drawings account and a credit to cash. Drawings reduce the owner's stake in the business.
Owner Drawings — Simple Definition
Drawings are personal withdrawals the owner takes from the business. When the business owner pays themselves — taking money out for personal living expenses — that is a drawing, not a business expense.
Throughout Year 1, John withdraws $24,500 from the business for his personal living expenses — rent, food, and family costs. This is recorded as Owner Drawings: $24,500. It reduces John's equity from $58,000 to $33,500. Drawings are not recorded as a business expense — they are an equity reduction, because John is simply taking back part of his own investment.
Drawings are not a business expense. They are not tax-deductible. They reduce the owner's equity stake. If you take too much out too soon, you can hollow out the financial base of your own business.
Quick Reference: Top Accounting Terms at a Glance
| # | Term | One-Line Definition | John's Example |
|---|---|---|---|
| 1 | Assets | What the business owns | Cash, inventory, van, shelving |
| 2 | Liabilities | What the business owes | $15K bank loan, $5K supplier payable |
| 3 | Equity | Owner's net stake in the business | $50K capital + $8K profit − drawings |
| 4 | Capital | Owner's original investment | $50,000 invested on Day 1 |
| 5 | Revenue | Total money earned from sales | $95,000 fabric/garment sales |
| 6 | Expenses | Costs paid to run the business | Rent, wages, utilities = $36,000 |
| 7 | Gross Profit | Revenue minus COGS | $95K − $57K = $38,000 |
| 8 | Net Profit | Gross profit minus all expenses | $38K − $36K = $2,000 |
| 9 | Loss | When expenses exceed revenue | Would occur if costs exceeded $95K |
| 10 | COGS | Direct cost of products sold | $57,000 in fabric/garment costs |
| 11 | Inventory | Stock held for sale | $30,000 fabric & garments |
| 12 | Cash | Immediately available money | $10,000 in business bank account |
| 13 | Accounts Receivable | Money customers owe the business | $3,500 from clothing shop customer |
| 14 | Accounts Payable | Money business owes suppliers | $5,000 to fabric supplier |
| 15 | Working Capital | Current assets minus current liabilities | $43,500 − $8,000 = $35,500 |
| 16 | Debit | Left-side entry; increases assets & expenses | Debit inventory when stock purchased |
| 17 | Credit | Right-side entry; increases liabilities & equity | Credit cash when cash is paid out |
| 18 | Journal Entry | First formal record of a transaction | Dr Inventory $8K / Cr Cash $8K |
| 19 | General Ledger | Master book of all accounts | All of John's accounts organized by type |
| 20 | Trial Balance | Verification that debits = credits | Both sides = $153,800 ✓ |
| 21 | Balance Sheet | Financial position at a specific date | Total Assets = Total L + E = $53,500 |
| 22 | Income Statement | Profit/loss over a period | Revenue $95K → Net Profit $2K |
| 23 | Cash Flow Statement | Actual cash in and out over a period | Tracks cash regardless of credit sales |
| 24 | Depreciation | Annual reduction in fixed asset value | Van: $1,500 per year over 5 years |
| 25 | Bookkeeping | Day-to-day recording of transactions | Recording every sale and payment daily |
| 26 | Accrual Accounting | Record when earned/incurred, not when cash moves | December sale recorded in December |
| 27 | Owner Drawings | Personal withdrawals by the owner | $24,500 taken for personal use |
| 28 | Current Assets | Assets convertible to cash within one year | Cash, inventory, AR |
| 29 | Fixed Assets | Long-term assets used in operations | Delivery van, shelving |
| 30 | Purchases | Goods bought by the business for resale | $57,000 in fabric/garments bought |
✅ Key Takeaways
- The accounting equation (Assets = Liabilities + Equity) is the foundation of every financial record in every business.
- Assets are what you own; liabilities are what you owe; equity is what you are worth after settling all debts.
- Revenue is total sales; profit is what remains after all costs are deducted. High revenue does not guarantee profit.
- Gross profit measures product efficiency; net profit measures overall business health.
- COGS is the direct cost of goods sold and is calculated as: Opening Inventory + Purchases − Closing Inventory.
- Accounts receivable is money customers owe you (asset); accounts payable is money you owe suppliers (liability).
- Every transaction in double-entry accounting has both a debit and an equal credit.
- Journal entries are the raw record; the general ledger organizes them; the trial balance verifies them; financial statements report them.
- Depreciation is not a cash expense — it is the annual accounting cost of using a fixed asset.
- Accrual accounting records revenue when earned and expenses when incurred — regardless of when cash moves.
- Owner drawings are not expenses — they are equity reductions. Excessive drawings can destabilize a business financially.
- Working capital (current assets − current liabilities) measures short-term financial health. Positive working capital = stability.
📋 Summary
Accounting is not complicated — it is logical. Every term in this guide connects to one central truth: a business has things it owns (assets), things it owes (liabilities), and the difference belongs to the owner (equity). Every transaction — from John buying fabric to John paying rent to John withdrawing cash for personal use — follows the same system of recording, classifying, and reporting.
You followed John Smith from his first $50,000 investment through purchasing inventory, hiring staff, taking a loan, making sales, collecting from customers, paying suppliers, calculating profit, and preparing financial reports. Every step mapped to a real accounting concept.
The accounting cycle flows in one direction: Transactions → Journal Entries → General Ledger → Trial Balance → Financial Statements. Master this flow and you understand the backbone of every business's financial system.
To go deeper, explore the accounting cycle explained step by step, understand the 5 types of accounts, or dive into journal entries with practical examples.
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Sales receipts
Supplier payments
Wages paid
Rent paid
Purchase of van
Sale of equipment
Property investments
Loan to others
Bank loan received
Loan repayments
Owner capital invested
Owner drawings
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