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Basic Accounting Terms


Working Capital :


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Working Capital Defined as the difference between a company's current assets and current liabilities, working capital is a measure of a company's short-term liquidity – more specifically, its ability to cover its debts, accounts payable and other obligations(the responsibility to meet the terms of a contract.) that are due within a year. In a sense, it's a snapshot of a firm's financial health.


Working capital, also known as net working capital, is the difference between a company’s current assets, like cash, accounts receivable (customer’s unpaid bills) and inventories of raw materials and finished goods, and currents liabilities, like accounts payable.


Working capital = Current Assets – Current Liabilities.

Capital :


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It is amount invested in the business by its owners. It may be in the form of cash, goods, or any other asset which the proprietor or partners of business invest in the business activity.


Drawings :


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It represents an amount of cash, goods or any other assets which the owner withdraws from business for his or her personal use. E.g. if the life insurance premium of proprietor or a partner of business is paid from the business cash, it is called drawings. Drawings will result in reduction in the owners’ capital.


Net worth :


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In accounting, net worth is defined as assets minus liabilities. Essentially, it is a measure of what an entity is worth. For a company, net worth is the value of the company.



Investments :


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Investment or investing means that an asset is bought, or that money is put into a bank to get a future interest from it. Investment is total amount of money spent by a shareholder in buying shares of a company.


Debtor :


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A debtor can be an entity, a company or a person of a legal nature that owes money to someone else – your business, for example. If you have one or more debtors, that makes you a creditor. To put it simply, the debtor-creditor relationship is complementary to the customer-supplier relationship.


In other words, Debtors are those persons from whom a business has to recover money on account of goods sold or service rendered on credit.


These debtors may again be classified as under:


  • Good debts :

    The debts which are sure to be realized are called good debts.


  • Doubtful Debts:

    The debts which may or may not be realized are called doubtful debts.


  • Bad debts:

    The debts which cannot be realized at all are called bad debts. It must be remembered that while ascertaining the debtors balance at the end of the period certain adjustments may have to be made e.g. Bad Debts, Discount Allowed, Returns Inwards, etc.



Creditor :


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A creditor is a person to whom the business owes money or money’s worth. E.g. money payable to supplier of goods or provider of service. Creditors are generally classified as Current Liabilities.


Capital Expenditure :


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Capital Expenditure is the money a company spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure when the asset is newly purchased or when money is used towards extending the useful life of an existing asset, such as repairing the roof. Capital expenditure forms part of the Balance Sheet.


Revenue expenditure :


A revenue expenditure is an amount that is expensed immediately—thereby being matched with revenues of the current accounting period. E.g. repairs, insurance, salary & wages to employees, travel etc. The revenue expenditure results in reduction in profit or surplus. It forms part of the Income Statement.


A revenue expenditure is the amount of money spent by a business or organization on general operating costs such as rent, insurance, heating, maintenance etc.


Discount :


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Discount can be referred to as a deduction in price. The seller deducts the discount from the gross or total price and the buyer is supposed to pay the net amount.


The two types of discount are:


  1. Cash Discount :

    Cash discount is allowances or concession given by the seller to the buyer. This discount is offered to encourage the buyer for quick payment or settlement. It is allowed for immediate payment of cash or payment within a short period.


    It is normally shown in quotation and invoice. It is deductible from the total price and the buyer is requested to pay only to the net amount. It is usually stated in the percentage form.


    Example : This has to be recorded in the books of accounts. And this is calculated after deducting the trade discount. e.g. if list price is 15000 on which a trade discount of 20% and cash discount of 2% apply, then first trade discount of 3000 (20% of 15000) will be deducted and the cash discount of 2% will be calculated on 12000 (15000 – 3000). Hence the cash discount will be 240/- (2% of 12000) and net payment will be 11,760 (12,000 - 240)


  2. Trade Discount : (wholesaler to retailer)

    Trade discount is the reduction in the catalogue price of the goods. Allowed only if the quantity ordered by the buyer is quite large. Its purpose is to encourage the buyer to make bulk purchases. It is allowed on cash as well as credit sales.


    It varies according to the quantity of order.


    Example : The list price of a TV set could be ` 15000. The wholesaler may allow 20% discount thereof to the retailer. This means the retailer will get it for ` 12000 and is expected to sale it to final customer at the list price. Thus the trade discount enables the retailer to make profit by selling at the list price.


Audit :


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Audit is the examination or inspection of various books of accounts by an auditor followed by physical checking of inventory to make sure that all departments are following documented system of recording transactions. It is done to ascertain the accuracy of financial statements provided by the organization.


GAAP (Generally Accepted Accounting Principles) :


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Generally accepted accounting principles (GAAP) are the guidelines and standards used in financial accounting and reporting all non-government organizations. They are the universal standard by which all financial accounting and reporting must confirm.


Financial accounting and reporting refers to tracking financial information and preparing financial statements that a company presents to the public.



Dividend :


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A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, paid to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.


Dividends are distributions of profits or other assets to shareholders from a corporation.


Net Profit :


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Net profit means the amount by which income from sales is larger than all the expenditure.


net profit is calculated by subtracting a company's total expenses from total revenue, thus showing what the company has earned (or lost) in a given period of time (usually one year).


Cash flow :


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It is defined as a measure of a company’s financial health. Equals cash receipts minus cash payments over a given period of time; or equivalently net profit plus amounts charged off for depreciation, depletion, and amortization.


Depreciation:


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In accounting terms, Depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic manner until the value of the asset becomes zero or negligible.


An example of fixed assets are buildings, furniture, office equipment, machinery etc. A land is the only exception which cannot be depreciated as the value of land appreciates with time.


Accrual Accounting :


When transactions are recorded in the books of accounts as they occur even if the payment for that particular product or service has not been received or made, it is known as accrual based accounting.

This method is more appropriate in assessing the health of the organization in financial terms.



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