These are accounting term definitions you should know if you are a freelancer or a small business owner
As a freelancer, managing your finances isn’t just about chasing clients and delivering exceptional work. It also involves grasping the basics of accounting term definitions and concepts. Don’t worry; I’m here to make it simple and friendly. In this blog post, I’ll dive deep into accounting terms, helping you decode the financial language and empowering you to understand and break down financial concepts that relate to your finances.
An asset is something valuable you own. Assets come in two flavours:
- Fixed Assets: these are the things you own for the long haul, like your trusty laptop or your camera. They are typically used over a long period of time (at least a year) and you would be able to make money out of them by either using them as part of your business operations, or by selling them.
Example: Your laptop, bought for £1,000, is a fixed asset. If you own a property, that is also considered a fixed asset.
- Current Assets: these are things you own that can quickly turn into cash within a year, like the money in your business bank account or the invoices waiting to be paid.
Example: That £500 sitting in your business bank account is a current asset.
Liability (Debts and Promises): liabilities are, very simply, the money you owe to others.
Example: If you borrowed £1,000 from a friend to invest in your freelance business, that £1,000 is a liability. Or, if you took up a business loan to be able to invest in your business, that would also be a liability, as sooner or later you would need to pay it back.
Equity/Capital/Reserves: these terms all point to your stake in your business. It’s what you truly own when you settle your debts. Basically: they are what would be left for you if you sold all of your assets and then paid all of your liabilities.
Example: If your assets are worth £5,000, and you owe £2,000 in liabilities, your equity or capital is a cool £3,000.
Income/Revenue: Income or revenue is the cash you earn from your job/s before you pay any expenses or tax.
Example: Earning £2,000 from your freelance gigs this month is your income or revenue.
Profit: this is the money that remains after you’ve subtracted all your expenses from your income. It’s essentially your reward for your hard work, and what your freelance taxes bill will be based on.
Example: If you earned £2,000 and spent £500, your profit is a sweet £1,500.
Cashflow: this is the flow of cash in and out of your freelance business. Trying to predict when your cash will actually hit or leave your bank account is important to ensure that you don’t go in overdraft, and that you have enough cash in the bank to face your business expenses.
Example: you raise an invoice in May, but your client pays it in July.
Budget: a budget is your financial game plan. It tells you how much you expect to earn and spend over a set period of time.
Example: ofer the financial year, you expect to earn £30,000 in sales, and spend £5,000 in fixed costs and £7,000 of direct costs, leaving you a profit of £18,000. You will need to monitor your income and expenditure during the year to see how well you’re performing against the budget you set, and whether you are overspending or earning less that your targets.
8. Balance Sheet
Balance Sheet: this report shows your assets (eg: cash in your bank, your fixed assets, unpaid sales invoices), liabilities (eg: unpaid purchase invoices, loans), and what you truly own at a specific point in time.
It essentially displays everything you own, everything you owe, and the difference between the two. It is very helpful to have a good picture of your liquidity (how much cash you have available immediately) and your solvency (how good you are at paying your debts).
9. Profit & Loss Report
Profit & Loss Report: this report is like your financial scorecard. It tells you how much you earned, how much you spent, and your profit over a specific period.
Example: Your yearly profit & loss report reveals £24,000 in earnings, £12,000 in expenses, and a delightful profit of £12,000.
10. Break-even Point
Break-even Point: this magical point happens when your income equals your expenses, leaving you neither in profit nor loss.
This is a helpful figure to understand, as it tells you how much you need to earn to not be at a loss. You should be aware of your break even point so you know at a glance if and when you start being profitable profitable.
11. Fixed Costs
Fixed Costs: these are your steady bills, the ones that don’t care how busy or quiet your freelance life is. Whether you engage in 100 projects or zero, these costs will stay the same
Example: your monthly office rent, your software subscriptions, your professional memberships.
12. Variable Costs
Variable Costs: variable costs are the expenses that dance to the rhythm of your workload. The more projects you take or, or the more products you sell, the more variable costs you incur, because they are grow with your output.
Variable costs are also called direct costs, or costs of sales.
Example: if you own an online shop where you sell bracelets, the materials you use to make those bracelets are variable costs, as you will have to buy more of them if you run out of bracelets to sell.
13. Net Worth
Net Worth: this figure is like your financial health score. It’s what’s left when you deduct all your liabilities from your assets. Thai term is typically used for individuals rather than businesses or organisations.
To know what your net worth is, you have to know the value f the following things:
- Your assets: a few examples of these include property you own, jewellry/furniture/other possessions that hold value, investments, savings, the cash you have in your current account.
- Your liabilities: such as credit card debt, loans (may that be from banks or people you know), student debt, and any other debt under your name.
The difference between the two is your new worth.
14. Taxable Income
Taxable income is the income that you have to declare in your tax return because it is subject to tax. You don’t pay taxes on all of your income: for examples, lottery wins are tax-free, and so are some specific grants. However, most of the income that you earn as part of your commercial trade will need to be included in your freelance tax return.
Here are some examples of income you do and don’t pay taxes on.
15. Capital Gains
Capital Gains: these are the profits you make when selling stuff like stocks or property, or when you get an inheritance. You are normally expected to pay tax on this profit: the laws and regulations on the capital gains tax are quite complex: make sure you read up on the government’s website if you need to familiarise yourself with anything that concerns capital gains.
16. Tax Avoidance vs. Tax Evasion
- Tax Avoidance: this means legally reducing your tax bill. This might be done by maximising your tax deductions, tax breaks, income exclusion, and loopholes.
- Tax Evasion: this means that breaking the law to dodge taxes. This might be done in many was, for example through hiding income, submitting the wrong information in your tax return, or committing any other type of tax fraud.
17. Credit Score
A credit score is like your financial report card, telling lenders how trustworthy you are when it comes to borrowing money.
You can check your credit score by using companies such as Experian. The closer your score is to 999, the better your credit score is, and the easier and cheaper it will be for you to borrow money.
You should aim for your credit score to be at least 700. There are many ways to improve your credit score: here are tried and true methods to improve your credit score quickly and easily!
This article was all about the accounting terms definition that all freelancers should understand