As in all sectors, the financial sector has wording that often leaves the lay person boggled. Here are a few terms that we casually throw about, which we may not really know the meaning of:
Assets: an item that is regarded to have value. This could be in the form of fixed assets like property, machinery and computers or it could be current assets like cash or people that owe you money (debtors).
Capital: Cash or assets used by a company or individual to generate income
Liability: this is something owed to another person or company. Long term liabilities are thing like bank loans and mortgages. Short term liabilities are things like overdue accounts (telephone, electricity and gas) that are outstanding or people that you owe money to (creditors) for goods or service you have already received.
Depreciation: This is the loss of value of an asset. To a business this loss of value cannot be reclaimed by selling the asset, so it becomes an expense to the business. . It is important for a business that depreciation becomes an expense as it lowers their tax bill. Some assets depreciate quicker than others. Computers depreciate quickly while buildings depreciate very slowly
Prepayments: at the end of a financial year, a company needs to produce the most accurate accounts possible. In order to do this income and payments need to be assigned to the right year. As things are usually a bit messy with things overlapping the year end, adjustments need to be made. Prepayment is one of these adjustments. It is where you have an account like a broadband subscription that you have paid upfront for the year for, but that year does not fit neatly into your financial year. The amount that covers part of the contract that falls into the next year for your broadband service needs to be put back as profit into your current year – this is a prepayment.
Accruals: this is essentially the opposite of a prepayment. An overdue account that needs to be paid but the payments date does not fall into the current financial year is essentially money owed but not matched with a payment. The cost of what is owed needs to be put against the current years accounts as an expense which will reduce profits, this transaction is an accrual.
Balance Sheet: this lists the assets and the liabilities for a financial period (usually a year). At the bottom is a summary of how much capital is in the company. This is worked out by subtracting the liabilities from the assets. This is very useful to see the value of the company at any given time. If the assets are smaller than the liabilities, then the company is in serious trouble.
Trading Profit and Loss: this is a running summary of the income and expenditure of a company. It helps you see what the company has brought in and what the company has spent its money on. It gives a good idea as to how the business is managed and if it is making a profit
Trial Balance: in a company’s books each transaction needs to be placed in an appropriate account. All assets, liabilities and expenses need to be grouped together as they are treated in different ways. A trial Balance is a list of these accounts with the values in them. It is used to spot errors in the accounting process as each value entered into the books is entered twice and if they don’t match up, it should show up on the Trial Balance
Audit: In larger companies managers (or Directors) run the company. These managers are not necessarily the owners of the company yet they have full access to the finances of a company. In order to verify the accounts that the managers produce and ensure that they are not masking or hiding something an independent person assesses the accounts to ensure that they are accurate. This is known as an audit.
Debit and credit: Often people get their definitions of debit and credit from their bank statements. Essentially a debit is money coming into a business or money that is owed to you and credit is money going out of a business or money that you owe. However on your bank statements this is the opposite way around. The reason for this is that your bank statement is shown from the point of view of the bank. Money coming into the bank or owed to the bank is a debit, but from your point of view it is a credit. Reversely, money owed by the bank to you or money that you have stored in the bank is a credit, yet to you it is a debit.