Financial accounting terminology can sound like a foreign language sometimes.
Sometimes referred to as the statement of financial position, the balance sheet represents a snapshot of the company and its financial status at a specific point in time. On one side you have the assets (what the company owns), and on the other you have the liabilities (what the company owes) and equity (the net difference between assets and liabilities – what the owners of the company could be entitled to). It is called a balance sheet because both sides should always equal: Assets = Liabilities + Equity. Not-for-profit entities are a little bit different in that they exist for the benefit of the public and don’t have owners. Instead of equity they have “net assets” that they can build to maintain future operations and continue to serve the public interest for years to come.
The income statement or “P&L” (short for profit and loss), shows the financial results of the company for a period of time. The income statement generally shows revenues for the period at the top, followed by cost of sales, other operating expenses, and other income/expense. When all of the above are added and subtracted together the reader can see whether or not the company was profitable that period.
Accounts receivable represents amounts that have been billed to customers and are owed back to the company. This is an asset to the company and is presented on the balance sheet. Revenue for this has already been recognized in the income statement, as the company has completed the work necessary to have a claim to the future cash receipts from the customers.
The accounts payable line on the balance sheet is inverse to the receivables mentioned above – accounts payable represents amounts for which the company has been invoiced by their suppliers/vendors and owe as of the balance sheet.
Unearned or Deferred Revenue
Simply put, unearned revenue is money received from a customer in advance of performance on the part of the company. Maybe you have not built and/or shipped the customer’s goods, perhaps you have not provided services to them yet. This is a liability on the balance sheet and not recognized as revenue through the income statement until the company has performed what they need to in order to earn it.
Fixed Assets and Depreciation
Larger purchases of, for example, machinery and equipment, furniture and fixtures, buildings, building improvements, etc., are recorded as fixed assets on the balance sheet. Many of these provide benefit to the company over at lease a few years (and much longer for buildings), yet they obviously do not last indefinitely. For financial accounting purposes, the company depreciates (that is, writes down the asset and recognizes a corresponding expense) each year of the asset’s life until it is fully depreciated to zero.
That was a lot to unpack and we only covered 6 common financial accounting terms! Please stay tuned as we plan on presenting a “part 2” in the near future.