Basic Accounting Concepts Every Business Owner Should Understand
In this episode of QuickBooks Mastery for Small Business Success, Lee Davis and Erica Northrup break down some of the most important basic accounting concepts business owners need to understand.
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For many entrepreneurs, accounting terminology can feel intimidating. But understanding these foundational concepts makes it much easier to properly set up and use QuickBooks.
It can also help business owners:
- Make better financial decisions
- Understand reports more clearly
- Avoid costly tax mistakes
Why Basic Accounting Matters
Even if you are not an accountant, having a basic understanding of accounting helps you:
- Organize your books correctly
- Communicate more effectively with your accountant or bookkeeper
- Better understand your financial reports
- Save money by handling transactions correctly
The more familiar you are with these concepts, the more confidence you’ll have managing your business finances.
Bookkeeping vs. Accounting
Although people often use these terms interchangeably, they are not the same.
Bookkeeping
Bookkeepers:
- Record transactions
- Organize financial information
- Reconcile accounts
Their role focuses on maintaining accurate records.
Accounting
Accountants:
- Analyze financial information
- Prepare taxes
- Explain the financial story behind the numbers
They help business owners understand what the data means and how it impacts the business.
Income
Income refers to how your business makes money.
This could include:
- Selling products
- Providing services
- Rental income
- Job income or contracts
Understanding your different income streams is essential for accurate reporting and business planning.
Cost of Goods Sold (COGS)
Cost of Goods Sold includes the direct costs associated with creating or delivering a product or service.
This may include:
- Materials
- Direct labor
- Production-related costs
Tracking these costs accurately helps business owners better understand profitability and pricing.
Expenses
Expenses are the costs required to operate the business.
There are two primary types:
Fixed Expenses
These stay relatively consistent each month, such as:
- Rent
- Insurance
- Subscription services
Variable Expenses
These fluctuate depending on business activity, such as:
- Supplies
- Shipping
- Utilities
Understanding the difference helps with budgeting and cash flow planning.
Owner’s Draw
An Owner’s Draw is not considered a business expense.
Instead, it represents money the owner takes out of the business for personal use.
This distinction is important because owner compensation is treated differently depending on business structure.
Net Profit
Net Profit is what remains after expenses are deducted from income.
This includes considering:
- Cost of Goods Sold
- Operating expenses
- Depreciation and other business costs
Net profit is one of the clearest indicators of overall business performance.
Assets
Assets are anything your business owns.
There are different types of assets:
Liquid Assets
Assets that can quickly become cash, such as:
- Cash itself
- Accounts receivable
Fixed Assets
Long-term items used to generate income, such as:
- Equipment
- Vehicles
- Machinery
Erica and Lee also note an important guideline:
- Purchases over $2,500 are generally treated as assets
- Purchases under $2,500 are often treated as expenses
Liabilities
Liabilities are anything your business owes.
Examples include:
- Credit cards
- Loans
- Accounts payable
There are two primary categories:
Short-Term Liabilities
Debts due relatively soon, such as credit cards.
Long-Term Liabilities
Debts repaid over longer periods, such as business loans.
Importantly, liabilities are not expenses—they represent obligations the business still owes.
Equity
Equity represents what remains after liabilities are subtracted from assets.
Assets−Liabilities=Owner’s Equity
Equity can include:
- Retained earnings
- Owner contributions
- Owner draws
- Current year profit
This number reflects the owner’s financial stake in the business.
Profit & Loss Statement
The Profit & Loss Statement shows financial performance over a period of time.
It includes:
- Income
- Expenses
- Cost of Goods Sold
- Net profit
- Depreciation
However, it does not show how much debt the business has.
The Balance Sheet
The Balance Sheet provides a snapshot of the business at a specific point in time.
It shows:
- What the business owns (Assets)
- What the business owes (Liabilities)
- The overall value of the business (Owner Equity)
Together, the Profit & Loss Statement and Balance Sheet provide a more complete picture of financial health.
Gross Income
Gross Income is calculated by subtracting Cost of Goods Sold from total sales.
Gross Income=Total Sales−Cost of Goods Sold
This helps business owners understand profitability before operating expenses are considered.
Cash vs. Profit
One of the most important concepts business owners need to understand is the difference between cash and profit.
Cash
Cash can change quickly depending on:
- Payments received
- Bills paid
- Timing of transactions
Profit
Profit reflects:
- Income minus expenses
- Overall business performance over time
A business can have cash in the bank and still be unprofitable—or be profitable while experiencing temporary cash flow challenges.
That distinction is critical when evaluating business health.
Final Thoughts
Accounting is the basis for QuickBooks, so with this short overview of accounting terms, you should have a better understanding of the fundamentals needed to master your QuickBooks. This is the first of two episodes that will be on basic accounting, so stay tuned for the next episode.
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