A Layman’s Guide to Key Accounting Terms

From “statutory audit” to “accruals,” accounting is packed full of phrases carry significant weight in financial reporting and analysis.

audit analysis

This guide aims to demystify some of the most common accounting terms, providing a clear, accessible understanding for business owners, students, and anyone looking to navigate the financial landscape more effectively.

Statutory Audit

A statutory audit is a legally required examination of an organisation’s financial records. Its principal aim is to verify whether an organisation’s financial statements provide a true and fair view of its financial performance and position so it is important to understand statutory audit meaning.

In the UK, statutory audits are compulsory for public companies, large private companies, and certain other entities, promoting transparency and accountability to shareholders and the public. Conducted by independent, qualified auditors, this process scrutinises financial records’ accuracy and compliance with pertinent accounting standards and regulations.

Accruals

Accruals represent accounting entries that denote revenues earned or expenses incurred, which have not yet been recorded through daily financial transactions. The accrual basis of accounting mandates that these events be recognised in the financial statements of the period they occur, irrespective of when the cash transactions related to them are executed. This principle ensures financial statements comprehensively and accurately reflect a company’s financial health, including debts owed or revenues not yet received.

Depreciation

Depreciation pertains to allocating the cost of a tangible asset over its useful life. It accounts for the decrease in value of an asset over time, due to use, wear and tear, or obsolescence. Employing this accounting practice enables companies to write off the value of an asset gradually, impacting the balance sheet and income statement. Depreciation is vital for gauging the true value of a company’s assets and its profitability over time.

Capital Expenditure (CapEx)

Capital expenditure, or CapEx, refers to the funds utilised by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. This type of expenditure is viewed as an investment in the company’s future operations. Unlike routine expenses (operating expenses), CapEx is capitalised on the balance sheet and then depreciated or amortised over the asset’s life, reflecting its consumption over time.

Liquidity

Liquidity measures a company’s capability to meet its short-term obligations using assets that can be swiftly converted into cash. This term encompasses the ease of converting assets into cash (asset liquidity) and a company’s capacity to pay its debts as they fall due (financial liquidity). High liquidity indicates a robust position to cover immediate and short-term liabilities, crucial for maintaining operational stability and solvency.

Gross Margin

Gross margin denotes the difference between revenue and the cost of goods sold (COGS), expressed as a percentage of revenue. It assesses how efficiently a company uses its resources to produce goods and services, serving as a pivotal indicator of financial health, operational efficiency, and pricing strategy. A superior gross margin suggests that a company retains more capital on each pound of sales, which can be allocated towards other expenses, savings, or profit.