In order to become successful in the business world, every entrepreneur should understand accounting terms that are used regularly by business owners and accountants.
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Here, we cover accounting terms that start with the letters D, E and F.
Deferred Tax Asset
Deferred tax asset is an asset in a company's balance sheet that could be used to reduce the company's future income tax liability. This type of asset is often created from a previous net loss or by acquiring a company that already carries this asset on its balance sheet.
Deferred tax assets are only recorded if it is likely to be used in the future. In other words, if a company is going bankrupt and closing its doors, deferred tax assets will not be recorded.
Certain assets lose value over time for various reasons: obsolescence, wear and tear, usage, etc. Depreciation measures this loss of value. Depreciation measures the loss of value from the deterioration of quality rather than the reduction of quantity. Assets that are depreciated generally have a fixed service life, such as computers and machineries.
The original cost of purchasing the asset minus the asset's expected salvage value (if any) is written off as an depreciation expense over the asset's economically useful lifespan until it reaches 0. There are many ways to depreciate an asset. How a company chooses to depreciate an asset may be influenced by tax purposes.
Certain assets have a limited income-producing lifespan. These assets are classified as diminishing assets. Examples of diminishing assets are copyrights, patents, contracts, etc.
Direct labor is an expense item that is part of cost of goods sold. Direct labor is the labor that goes directly into the production of the goods or services sold by the company. An example of direct labor is the employee who makes the hamburger while an example of indirect labor is the employee who is in charge of maintaining the equipments.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is used frequently in business valuation methodologies because, in theory, it represents a company's profitability before non-operating expenses.
EBITDA is not a measure of profitability or cash flow. In fact, companies can have positive EBITDA and still have negative profitability and/or negative cash flow. Nonetheless, it is a useful financial metric and should be well understood by aspiring entrepreneurs and active business owners.
First In-First Out (FIFO)
First in-first out, or FIFO, is one of the two main methods for determining the book value of a business's inventory. (The other method is last in-first out, or LIFO.) The value of an inventory is the sum of the cost of acquiring or producing the inventory and each unit or group of units are produced or acquired at differing prices.
FIFO reduces the value of the inventory by the cost of acquiring or producing the newest inventory. Using the FIFO method, the value of an inventory is determined by the oldest addition to the inventory since the cost of the newest additions is quickly reduced as inventory gets depleted.
Fixed assets are non-current assets also referred to as property, plant, and equipment (PP&E). Fixed assets are cannot be quickly be converted to cash, are tangible assets, receive a depreciation allowance, and tend to deteriorate or depreciated through quality, not quantity. Examples of fixed assets are land, building, vehicles, office equipment, furnishing, plant, machinery, etc.