Top 10 accounting terms that every contractor should know

As a contractor running your own business, understanding the financial side of things is just as important as getting a project done. Accounting is a crucial part of organising a business, and whether it’s done by you or your accountant, calculating revenue for your contracting business each month is essential. Learning the most commonly used accounting terms will help you improve your understanding of finance and what an accountant does on a day-to-day basis. Here are the top 10 accounting terms that every contractor should know, as told by FreeAgent.

1. Accountant

An accountant can be a great asset to a contractor. A good accountant will help you stay on top of your finances by analysing the financial data from your accounts to verify accuracy, assessing your profitability and providing strategic recommendations. You may also hear the term ‘bookkeeper’ used. Both accounting and bookkeeping involve the handling of financial data, but bookkeeping relates to how the data is gathered and stored, while accounting relates to the interpretation of this information for financial forecasting and to inform business decisions.

2. Asset

An asset is something a business owns. These may be large items of equipment such as computers, cars and machinery, which are called 'tangible fixed assets'. They may also be large investments your business has made, which are of value but can’t be seen and touched, such as patents or franchise fees. These are called 'intangible fixed assets'. Your business may also have ‘current assets’ that can be quickly converted into physical cash, like stock, money owed by your customers ('trade debtors') and cash in the bank account.

3. Liability

A liability is something a business owes. A ‘current liability’ is money that your business will have to pay within a year. Examples include money owed to HMRC, such as VAT or Corporation Tax, and money owed to suppliers, such as a solicitor or accountant. A ‘long-term liability’ is money that your business will have to pay in more than a year's time, such as a bank loan or mortgage.

4. Balance sheet

A balance sheet is a report that shows how much a business owns and owes at a given point in time. The balance sheet sums up all a business's assets, fixed and current, and then subtracts all its liabilities, current and long-term, from that total. The total will be equal to the sum of the business's capital accounts, because if the business sold all its assets and paid all its debts, that would be the amount left for the business owners to keep. If the total of the balance sheet is a negative number, the business owes more than it has the resources to pay - in other words it is 'insolvent'.

5. Accounts payable

Accounts payable refers to money owed to suppliers who have sent your business goods, or supplied it with services, who you haven't yet paid. These are also known as ‘trade creditors’.

6. Accounts receivable

Accounts receivable is the opposite of accounts payable - it refers to the amount of money that your customers haven't yet paid you for your goods or services. These are also known as ‘trade debtors’.

7. Credit and debit

A credit is an entry in your accounts that reduces what you own or increases your profit, while a debit is an entry that increases what you own or reduces your profit.

8. Expense

An expense is a type of business cost. The word ‘expense’ can be used to describe several different types of cost - such as travel or office costs - but it usually indicates that the cost can be reimbursed in some way.

9. Limited company

A limited company is a type of business structure where the company has a legal identity of its own, separate from its owners (shareholders) and its managers (directors). Even if, as a contractor, you are the only shareholder and the only director, the limited company is still a separate legal entity. That means the company can enter into contracts, and be sued, in its own right. Each year, the company must file accounts and a confirmation statement with Companies House, which are available for public viewing, and a Corporation Tax return with HMRC.

10. IR35

IR35 is the term commonly used to refer to HMRC’s ‘off-payroll working’ rules. These rules allow HMRC to collect Income Tax and National Insurance in situations where a contractor operates through an intermediary (usually a limited company) and without this intermediary the contractor would otherwise be an employee of their client.

By understanding these top 10 accounting terms, you’ll be able to get to grips with some of the key financial elements involved in running your contracting business and gain a better understanding of your future finances.