Finance words and concepts

Accounting is the process of recording, checking and reporting on money. 

In a corporation, money comes in, money goes out, employees are paid, and day-to-day operations are carried out. For a corporation, accounting means keeping accurate records of all these financial transactions and using those records to prepare financial reports.
 

Accounting principles are the rules or standards used to record, manage and report financial information.

They have emerged over a long period of time. They aim to ensure that everyone does accounting in the same way – that is, they record and treat transactions the same so that accounts and reports are reliable and can be compared.

There are 2 main ways to record money coming into and going out of a corporation. These are called the ‘basis’ for accounting. You might hear them called ‘cash basis’ or ‘accrual basis’ accounting.

The difference is timing – when you record that an expense or income has happened.

Cash accounting

Cash accounting tracks the actual money coming in and out of your business on the dates the money is moved. 

In cash accounting, you record the transaction on the day you: 

• make a payment. For example, you buy fuel or supplies, or pay an invoice, bill or staff wages – you record the expense in your books when you pay
• receive a payment. For example, someone buys your goods, a customer pays an invoice you sent them, or a funding body releases a payment to you – you record the income in your books when you get their payment. 

Example: You do the work on Monday. You send an invoice on Tuesday. The payment is made on Thursday. You record the income as happening on Thursday's date. 

Pros and cons of cash accounting 

Pros: 

• It is a simple system that keeps track of your corporation’s cash flow.
• It suits smaller businesses if you mostly have cash transactions (for example, a hairdresser or market stall) 
• It gives you a picture of how much money you have in your till and your bank accounts.

Cons:

• It doesn't show money that is owed to you or money you owe to others, which doesn’t help when you’re making financial decisions.
• It could show you are profitable if you haven’t paid your bills or expended your grants. 

Accrual accounting 

If you use accrual accounting, you record expenses and income when they take place, instead of when cash changes hands. This way of accounting shows the amounts you owe to people and the amounts owing to you. 

In accrual accounting, you record the transaction on the day you:

• Incur a debt. For example, you place an order with a supplier even though you might not have to pay their invoice for 30 days.
• Incur revenue. For example, you give an invoice to someone for supplying goods or services to them even though they might not have to pay the invoice for 30 days.

Example:  You do the work on Monday. You send an invoice on Tuesday. The payment is made on Thursday. You record the income under Tuesday’s date even though you haven't been paid yet. 

Pros and cons of accrual accounting 

Pros: 

• It is helpful if you deal with lots of contracts or large amounts of money that doesn't get paid straight away (for example, tradies who provide a service then invoice for it later, corporations that receive grant payments at milestones or only once a year) 
• You have a much more accurate picture of your corporation’s financial position by showing money owed to you and money you owe others. 
• You can make financial decisions with more confidence.

Cons:

• It’s more work because you have to monitor invoices, purchase orders etc, not just the bank account.
• It is more complicated than cash accounting, so you’ll probably need a professional to help such as a bookkeeper or accountant.

An asset is something owned by the corporation that is valuable and contributes to generating revenue or helps to deliver the corporation's services. 

These things help the corporation run its business and provide services.

Examples assets are:

• cash at bank
• accounts receivable – money owed to the corporation by customers or other people
• inventory or stock – items to sell
• land
• buildings
• vehicles
• equipment and tools
• intangible assets – things the corporation owns that have value such as licences or trademarks.

Current vs non-current assets

Assets are usually divided into current or non-current (fixed) assets. 

Current assets are things the corporation can use, sell or turn into cash within 12 months. 

Non-current assets are things the corporation owns and expects to keep for more than 12 months. Sometimes they are called fixed assets.

An audit is a check of the corporation's money records.

It helps make sure the corporation's financial information is correct and can be trusted.

See our page on audits.

A balance sheet is a snapshot of the corporation's finances at a particular date. It shows what the corporation owns (assets), what it owes (liabilities), and what is left over after debts are paid.

It helps directors understand the corporation's financial position and whether it has enough assets to meet its obligations.

See our page on the balance sheet

A budget is a plan that estimates how much money will come into the corporation and how much money will be spent during a future period.

It helps directors decide how money should be used and check whether the corporation is spending money as planned.

See our page on budgeting.

All the money the corporation has available on demand. It includes bank notes and coins, petty cash, certain cheques, and money in savings or debit accounts.

Cash flows are the money coming into and going out of the corporation. The money coming in is called ‘cash inflows’ and the money going out is called ‘cash outflows’. 

Cash flows are usually split into: 

• operating activities 
• investing activities 
• financing activities. 

Cash flows from operating activities 

Cash inflows and outflows from operating activities are the money received and spent in the day-to-day activities of the business. 

Examples of inflows from operating activities

• Cash from sales to customers
• Grants received
• Donations and bequests received
• Interest received.

Examples of outflows from operating activities

• Payments to suppliers and employees
• Borrowing costs (interest paid).

Cash flows from investing activities

Cash inflows and outflows from investing activities show fixed assets bought and sold during the period.

Examples of inflows from investing activities

• Proceeds from the sale of property, plant and equipment
• Proceeds from the sale of investments.

Examples of outflows from investing activities

• Purchase of property, plant and equipment
• Purchase of investments.

Cash flows from financing activities

Cash inflows and outflows from financing activities shows borrowings and repayments of borrowings.

Examples of inflows from financing activities

• Proceeds from long term borrowings.

Examples of outflows from financing activities

• Repayment of borrowings
• Lease payments.

A person or organisation that the corporation owes money to.

Examples:

• a supplier of goods or services waiting for payment. 
• a bank has provided you a loan.
• a utility company if the bill is unpaid
• local council if rates are owed

Creditors expect to be paid on time. Directors should know who the corporation owes money to and when payments are due.

A person or organisation that owes money to the corporation.

Examples:

• A customer who has received goods or services but has not paid yet.
• A tenant who owes rent to the corporation.
• Another organisation that owes money to the corporation.

The corporation needs to collect money from debtors so it has enough cash to operate.

Depreciation is when something becomes worth less over time because it gets older, wears out, or becomes less useful.

Depreciation helps show the true value of the corporation's assets and the cost of using them over time.

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Technical version:

Depreciation is the accounting name for the value that assets lose over time. It only applies to tangible (or physical) non-current assets that have a limited effective (useful) life. Land is considered to have an unlimited effective life, so it doesn’t depreciate. All the others are called depreciable assets.

The loss of value can be from wear and tear (lots of kilometres on a car) or going out of date (computers no longer able to support modern software).

In accounting terms, depreciation takes the 'effective life’ of an asset and allocates the purchase cost across that many years in the financial statements.

Put simply, depreciation is regarded as the allocation of the cost of an asset over its estimated useful life. Depreciation doesn’t relate to what that asset might be worth now – only what it was bought for. An asset must be depreciated even if its value increases. Residual value is also known as the salvage or disposal value.

Depreciation is a non-cash expense. It is recorded in the profit and loss statement, but the only cash outlay is the purchase of the asset in the first place.

Equity is what is left after the corporation pays all the money it owes.

It shows how much of the corporation's assets belong to the corporation rather than its creditors.

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Technical version:

Equity represents the money the members have put into the corporation plus any increase in value of the corporation since it was formed.

The higher the equity, the more the corporation is worth.

The most common equity accounts are:

• retained profits/earnings
• reserves.

Expenses are the costs of running the corporation. 

It is the money the corporation spends. These can include things like:

• advertising
• bank charges and interest paid
• cleaning
• electricity, water, gas and telephone
• insurance
• motor vehicle expenses
• postage, printing and stationery
• rent
• salaries, wages and superannuation.

Directors need to understand what the corporation spends money on and whether its expenses are affordable

A 12-month period used for tax and accounting purposes. In Australia the financial year runs from 1 July to 30 June. Most corporations use the Australian financial year unless they have an exemption from the Registrar.

Income is all the money coming into the corporation. 

Examples of income:

• sales from a store
• government grants
• membership fees
• rent received
• interest from a bank account 

Income and revenue are often used interchangeably, but there is a small difference. Income includes revenue and other money received by the corporation. See also the explanation of revenue.

The goods or materials a business holds for sale. Inventory is counted as an asset in financial statements.

Insolvency means a corporation cannot pay its debts when they are due.

See our page on insolvency.

Liabilities are debts or money the corporation owes to other people or organisations.

Examples of liabilities are:

• bank overdraft
• accounts payable (or trade creditors) – unpaid supplier invoicesother payables (such as tax payable, superannuation payable etc.) – unpaid tax 
• grants received in advance
• provisions (annual leave, long service leave etc.)
• loans/borrowings payable.

Current vs non-current liabilities

Liabilities are usually divided into current or non-current liabilities. If a liability is expected to be paid within the next 12 months, it is called a current liability.

A liability not expected to be paid within the next 12 months is called a non-current liability.

A profit and loss statement is a report that shows income, expenses, and whether the corporation made a profit or a loss during a period of time.

See our page on the profit and loss statement.

A reporting period is the time covered by a financial report. For example, a month, quarter (3 months), or a year. 

Most reports required by the CATSI Act set the reporting period as the financial year.

Revenue is money earned from the corporation's main business activities. 

Revenue and income are often used interchangeably, but there is a small difference. Income includes revenue and other money received by the corporation. See also the explanation of income.

Example

A community store receives:

• $500,000 from store sales
• $50,000 grant funding
• $2,000 bank interest

Revenue = $500,000 (sales only)

Income = $552,000 (sales + grant + interest)

A statement of cash flows shows how much cash came into the corporation, how much cash went out, and how much cash was left at the end of the reporting period.

See our page on the statement of cash flows