Accounting probably wasn't the reason you decided to become an entrepreneur — and that's okay. You don't need to memorize accounting textbooks or speak fluent CPA to run a successful business.
But understanding a few key accounting terms can go a long way. The more you know about your numbers, the easier it is to make informed decisions, spot potential issues early and have more productive conversations with your accountant.
Consider this your cheat sheet to the accounting terms every small business owner should actually know.
1. Cash flow
Cash flow measures the money moving into and out of your business. When more money comes in than goes out, you're cash flow positive. That's where you want to be.
Positive cash flow means you can:
- Pay suppliers on time
- Cover payroll without breaking a sweat
- Handle unexpected expenses
- Invest in new equipment or growth opportunities
Negative cash flow doesn't necessarily mean your business isn't profitable — it could simply mean you're waiting for customers to pay their invoices. But if it becomes a pattern, it's worth addressing before it becomes a problem.
One of the smartest things you can do is review your cash flow regularly instead of waiting until year-end. With cloud accounting software like Xero, you can forecast future cash flow and spot potential issues before they catch you off guard.
2. Profit and loss (P&L) statement
Want to know whether your business is actually making money?
That's where your profit and loss statement comes in.
Also called an income statement, your P&L summarizes your revenue, expenses and profit over a specific period — usually monthly, quarterly or annually.
It answers one very important question: Did you make money or lose money?
A P&L isn't just something your accountant looks at during tax season. It's one of your best tools for understanding how your business is performing.
Reviewing it regularly can help you:
- Spot rising expenses
- Identify your most profitable products or services
- Make better budgeting decisions
- Plan for future growth
Are you preparing for the end of the fiscal year? Download this income statement example to help guide you through the process.
3. EBITDA
EBITDA stands for earnings before interest, taxes, depreciation and amortization.
Think of it as a way to measure how your business performs before financing decisions, tax strategies and accounting adjustments come into play.
Lenders, investors and potential buyers often use EBITDA because it makes it easier to compare businesses on a level playing field.
For many small business owners, you won't use EBITDA every day. But if you're applying for financing, bringing on investors or thinking about selling your business someday, it's a number worth understanding.
4. A few financial ratios worth knowing
Financial ratios sound complicated, but they're really just quick ways to measure the health of your business.
Here are three that come up often.
Gross margin
Gross margin tells you how much money you keep after covering the direct cost of producing your products or services.
Generally speaking, the higher your gross margin, the more room you have to cover overhead expenses and generate profit.
Current ratio
The current ratio compares what your business owns in the short term with what it owes in the short term.
If the ratio is above 1, you generally have enough current assets to pay upcoming bills.
If it's below 1, it may be time to keep a closer eye on your cash flow.
Debt-to-equity ratio
This ratio shows how much of your business has been financed through borrowing compared to owner investment.
A higher ratio isn't automatically bad — it often reflects a growing business — but it does indicate that debt plays a larger role in funding your operations.
Like most financial metrics, context matters. That's why it's helpful to review these numbers with your accountant instead of trying to interpret them in isolation.
5. Balance sheet
If your P&L tells the story of how your business performed over time, your balance sheet is a snapshot of where things stand today.
It summarizes three things:
- Assets: What your business owns, like cash, inventory and equipment
- Liabilities: What your business owes, including loans, taxes and unpaid bills
- Owner's equity: What's left after liabilities are subtracted from assets
Your balance sheet helps answer questions like:
- How financially healthy is my business?
- Am I carrying too much debt?
- Do I have enough assets to support future growth?
It's one of the first reports lenders and investors will want to see — and it's equally valuable for you as a business owner.
6. Accounts payable and accounts receivable
These two accounting terms are easy to mix up, but they're actually pretty straightforward.
Accounts payable (AP)
Accounts payable is money your business owes.
Think supplier invoices, utility bills or vendor payments that haven't been paid yet.
Accounts receivable (AR)
Accounts receivable is money your customers owe you.
You've done the work. You've sent the invoice. Now you're waiting to get paid.
The longer invoices remain unpaid, the more pressure they can put on your cash flow.
That's why staying on top of collections — and following up on overdue invoices — is just as important as making the sale in the first place.
One more thing to watch for: bad debt.
Sometimes customers simply don't pay. When it becomes clear an invoice won't be collected, it needs to be written off properly in your books.
7. Trial balance vs. general ledger
These two reports don't get nearly as much attention as your profit and loss statement or balance sheet — but they're working hard behind the scenes.
Your trial balance is a summary. It lists the ending balance of every account in your books at a specific point in time.
Your general ledger is the detailed version. It shows every transaction that makes up those account balances, including dates, descriptions and amounts.
Your trial balance is like checking your bank account balance.
Your general ledger is scrolling through every transaction to see exactly how you got there.
If you're ever wondering, "Where did that number come from?" your general ledger has the answer.
8. Dividends
If you own shares in your corporation, you may be able to pay yourself through dividends.
A dividend is a payment made to shareholders using your company's after-tax profits.
Unlike payroll, dividends aren't considered salary or wages, and they come with different tax implications.
Whether you should pay yourself through dividends, salary or a combination of both depends on factors like:
- Your personal income
- Your retirement goals
- CPP contributions
- Tax planning opportunities
- Your corporation's financial position
There's no one-size-fits-all answer — which is why it's worth talking through your options with your accountant before deciding how to pay yourself.
9. Operating vs. capital expenses
Not every business purchase is treated the same way for accounting purposes.
Operating expenses
Operating expenses (often called OpEx) are the everyday costs of running your business.
Think:
- Office supplies
- Software subscriptions
- Utilities
- Advertising
- Rent
- Professional services
These expenses are generally deducted in the year they're incurred.
Capital expenses
Capital expenses (CapEx) are investments in assets that will benefit your business for more than one year.
Examples include:
- Computers
- Office furniture
- Manufacturing equipment
- Company vehicles
- Major building improvements
Instead of deducting the full cost immediately, these assets are typically claimed over time through capital cost allowance (CCA), following CRA rules.
A good rule of thumb? If you're buying something that's expected to stick around for years, there's a good chance it's a capital asset.
10. Fiscal year vs. calendar year
Most of us live by the calendar year — January 1 through December 31.
Your business doesn't have to.
If you're incorporated in Canada, your company can generally choose its own fiscal year-end. That 12-month period becomes the basis for many of your accounting and tax deadlines.
For example, if your fiscal year ends on September 30, your business year runs from October 1 to September 30.
Choosing the right fiscal year can make budgeting, reporting and tax planning much easier.
If you're just starting your business, it's worth discussing your options before locking in a year-end date. A little planning now can save you headaches later.
11. Assets, liabilities and equity
If you remember only one accounting equation, make it this one:
Assets = Liabilities + Equity
Here's what it means:
- Assets are what your business owns, such as cash, inventory, equipment and accounts receivable.
- Liabilities are what your business owes, including loans, taxes and unpaid invoices.
- Equity is what's left after liabilities are subtracted from assets — essentially your ownership stake in the business.
Understanding this relationship makes it much easier to read your financial statements and see how financially healthy your business really is.
Understanding a handful of key accounting terms can help you have better conversations, make more informed decisions and avoid surprises when tax season rolls around.
Whether you have questions about cash flow, payroll, financial statements or planning for growth, we're here to help you understand the numbers behind your business — not just prepare them.
Need an accounting partner who speaks plain English? We'd love to help. Get in touch with the True North Accounting team to learn how our bookkeeping, accounting and advisory services can help your business grow with confidence.
Did you find this blog helpful? Read more about Small Business Basics topics that may be relevant to you and your small business.
