Learning about accounting is important if you are going to be a business owner.
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Accounting Terminology for Entrepreneurs is a series of articles that will help you understand some of the most commonly used terminologies in accounting.
In this article, we look at accounting terms starting with the letter G-L.
General and Administrative Expenses
"General and administrative expenses" is a expense category that includes all business expenses with the exception of 1) expenses that are directly attributed to the production of goods or services sold by the business and 2) expenses that are closely related to the production of goods and services. The distinction between general and administrative expenses and overhead expenses varies across businesses. Examples of general and administrative expenses are legal fees, salaries, rent, etc.
The intrinsic worth of a profitable business is usually more than the sum of its tangible assets. This excess value is called goodwill. Goodwill shows up on financial statements when a business is purchased at a price that is greater than the book value of the business. The excess amount paid for the business is labeled goodwill, an intangible asset that shows on the balance sheet.
Under GAAP, goodwill can only be impaired, not amortized. Impairment of goodwill is determined by the difference between the carrying value and the fair value of the business:
Carrying value= book value of assets + good will – liabilities
Fair value= present value of future cash flow using DCF analysis.
Impairment of goodwill = carrying value – fair value.
Examples of goodwill are brand names, intellectual properties, reputation, client relationships, etc. For some business, such as Coca-Cola, goodwill represents a significant part of its market-value.
Gross profit = revenue – cost of goods sold. Be careful not to confuse gross profit with net income. The figure for gross profit, unlike net income, does not deduct overhead, payroll, taxation, interest payments, and other expenses.
A hidden asset or liability is an asset does that does not appear or is not readily apparent on a balance sheet. Hidden assets/liabilities, whether by accident or design, is a very important component of business valuation. An example of a hidden asset is United Airline's Mileage Plus, a program that is estimated to be worth about $15 billion, at the time when the company filed for chapter 11 bankruptcy.
An intangible asset is generally an asset that is neither physical nor financial. Unlike physical or financial assets, intangible assets are difficult to measure, define, and financial statements frequently do not include all intangible assets. Examples of intangible assets are copyrights, patents, goodwill, etc.
A current asset, inventory is a stock of goods and materials currently held by a company for future sale or consumption. There are three main reasons why business may want to hold an inventory:
- Inventory may smooth over the lag time that exists in supply chains.
- Inventory act as a cushion for supply and demand uncertainties.
- Businesses may want to manufacture or purchase goods in order to achieve economy of scale and better leverage bargaining power. Inventory is often the unavoidable result of bulk purchases and production.
Last In-First Out (LIFO)
Last in-first out, or LIFO, is one of the two main methods for determining the book value of a business's inventory. (The other method is first in-first out, or FIFO.) 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. LIFO reduces the value of the inventory by the cost of acquiring or producing the oldest inventory. Using the LIFO method, the value of an inventory is determined by the newest addition to the inventory since the cost of the oldest additions is quickly reduced as inventory gets depleted.
Liabilities are claims against a business. Liabilities are settled by a future transfer of money, goods, services, or other assets from the business to the individual or entity that holds the claim. According to the International Accounting Standard Board, "A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits."
There are two categories of liabilities: current and long-term. Current liabilities are expected to be settled within one year or one business cycle. Examples of current liabilities are wages, taxes, accounts payable, etc. Long-term liabilities are liabilities that are not expected to be settled within one year. Examples of long-term liabilities are long-term debt, long-term leases, pension obligations, etc.