Essential finance foundations – principles and jargon

One of our jobs as financial directors is to train business owners and managers on the fundamental foundations of finance. By understanding the 3 different core statements/reports that make up a set of accounts – and the jargon that goes with them – you’ll become much more confident in your ability to translate the figures, and realise that accounts aren’t really quite as complex as they can first appear.

Over this next series of posts, we’ll explore the language you’ll come across in your accounting processes and the 3 key documents your finance department or accountant will put together for you to keep you updated on your position and prepare for annual filing.

Essential finance foundations – principles and jargon

Definitions of different accounting aspects are subject to some rather confusing naming conventions. Because many different words or terms can be used to explain the same thing, it can lead to a lack of confidence in many business owners – but in reality, once you know the conventions, you’ll soon realise that it’s not as complicated as it first seems.

Different terms for the same things can arise due to location e.g. whether you’re operating in the UK or internationally and the subsequent reporting standards, through different people collating and creating the reports or simply due to personal preference or convention from one business to the next.

If you’re looking at different accounting reports where different terms have been used for exactly the same thing, it can be pretty confusing – this is why learning the various terms and how they relate to each other is essential. This knowledge is the essential foundation required to understand your business finances.

During our training courses we explain any jargon we use as we go along, but here are a few examples you’ll come across:

Revenue (the money we get for the goods or service we sell) can also be known as:

Sales

Sales revenue

Turnover

Sales turnover

Income


A profit and loss report can also be called:

Income statement

Income and expenditure statement

Statement of income and expenditure

Statement of profit and loss

While many things may mean the same thing, you also need to watch out for terms that sound similar but are actually different. For example, accruals are different to the accruals principle, so in order to avoid confusion you can use an alternative term for the accruals principle, the matching principle, which is actually clearer as it means the process of matching income and costs by using invoice dates rather than the day you pay or receive cash.

So, talking of principles, these make up another essential foundation in understanding your business finances – along with the jargon/terminology you need to know, principles underpin pretty much everything you will see in your accounting reports.

5 key accounting principles 

Here’s a quick look at the core principles of accounting...


Accruals principle/matching principle – this means the process of matching income and costs. So when you show a profit (or loss) in your year’s profit and loss account, what you’re essentially doing is matching the revenue generated by your products or services with how much it’s cost you to do it. You use the date of your invoices to work out if something falls into your accounts or not - irrespective of whether you’ve received the money or paid out the money – which is one very big reason that profit and cash are not the same thing.

Prudence – this means assuming the worst case scenario. If you tend towards the optimistic you can end up with a misleading sense of success and ‘profit’ that may not actually come to fruition. Not all customers pay their bills for example, so you may have an invoice showing a sale, but don’t have the cash in the bank – it’s prudent to recognise they may not pay as soon as possible.

Materiality – this means making decisions about whether transactions are material (i.e. significant) enough to be treated in a particular way.

Substance over form – the means to treat something in the spirit in which it was intended to be treated. For example, you may have an operating lease on something you use for your business, but if the transaction actually works more like a finance lease, then you should treat it as such.

Consistency – you must always be consistent in your decisions and accounting. So for example, if you have something that you’re treating as a finance lease, then you must be consistent and always treat it as a finance lease for the entire duration. You can’t swap between the two.

This is only a brief overview of the essential terminology and principles you need to know – for a more thorough guide to all the foundations of finance, you can book a place on our courses here .


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