Bookkeeping - Terminology Made Simple

By Vikki Allen
There is no mystery to the basis of bookkeeping ie: for every debit there must be corresponding credits, but which is what and where does it go?

Lets first un-mystify some of the terminology and in future articles we can get down to practicalities.

INCOME -

This can be broken down into 2 groups,

1. Sales - This is the money generated from the sale of goods or services before taking anything off for costs or discounts etc.
2. Other Income - This is any other money received into the business by way of interest, discounts or anything not directly related to the product or service of the enterprise.

EXPENDITURE (Expenses) -

Again this can be broken down into 2 groups,

1. Cost of Sales - anything directly purchased, including labour (wages), to produce the stuff you sell.
2. Expenses - everything else you have to pay for to run the business.
Example: Say the business makes wooden boxes, the wood you buy and the carpenters wages are direct costs but the electricity used and the paper used for invoices are not. They are more like support services and therefore expenses.

PROFIT & LOSS -

Gross profit (or loss) is the difference between the sales and cost of sales.

Net profit (or Loss) is what's left after taking the expenses off the Gross profit and adding any Other Income.

Note: Profit does not necessarily equal money in the bank, your profit is a number on a page that could be represented by stock on the shelf, material in the factory, half completed projects or fixed assets. It is ironic but the business could be in heavy overdraft but still be profitable - this is called a cash flow problem (or 'the cheque is in the mail').

ASSETS -

These are also broken down into 2 groups.

1. Fixed Assets - owned by the business, such as buildings, plant & equipment, vehicles etc. Things that are necessary to generate the income and run the business that are going to be kept for a long time and cannot be easily converted to cash.
2. Current Assets - Things of a short term nature (under 12 months) easily converted to cash and of course cash itself, bank account, short term investments, debtors.

LIABILITIES -

Also broken down into 2 groups.

1. Long term liabilities - any loans, bonds, HP etc to be paid off over a period longer than 12 months.
2. Current liabilities - anything that needs to be paid out within the current financial year (12 months) such as creditors, short term loans and not forgetting the bank account if it is in overdraft.

OWNERS EQUITY -

The first thing to get our head around is that the owner of the business and the business itself must be seen as two separate individual entities, so even if you are the sole owner of your business - you are not the business itself.

Once this is understood it is easy to see that Owners Equity is the difference between the Assets and Liabilities and depending which way it swings could either be owed TO the owner or owed BY the owner to the business.

DEBTORS -

Those that owe the business money.

CREDITORS -

Those that the business owes money to.

INCOME STATEMENT -

A record of the day to day income and expenses of the business during the financial year. At the end of each financial year the values on the income statement are brought to zero for the start of the new year and only the profit or loss are carried over to the balance sheet.

BALANCE SHEET -

A snapshot of the status of a business at any point in time made up of the Assets, Liabilities and Owners Equity. These values which change according to movements in the business are carried forward from year to year.

DEBITS & CREDITS -

Note: Not the same as Debtors and Creditors (see above)

When recording your transactions you would divide your page into two columns - Debits on the left and Credits on the right (just remember Dogs first, Cats second). Now comes the 'which goes where'

Costs & Expenses - Debit
Income - Credit
Assets - Debit
Liabilities - Credit

TRIAL BALANCE -

Once you have sorted everything into your two columns, add each one up and they should balance with each other (if not you have boobed somewhere) - this is your trial balance and it is from here that all information is gathered to make up the Financial Statements of the business.

Vikki Allen is a Financial Manager with 15 years bookkeeping experience, an Advanced Diploma in accounting and a Post Graduate Diploma in Forensic Auditing & Criminal Justice from the University of KwaZulu Natal.

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