What do accounting categories mean?

These are fundamental accounting categories that describe the value of the wealth of a business or an entity. Assets refer to what an entity owns, for example, land, buildings, equipment, machinery, cars, computers. Assets also cover intangible goods such as a patent or a copyright. Those include cash, credits, that is the right to receive cash in the future, and stocks of goods and finished products. Liabilities relate to the debts that an entity has. The net wealth of an entity is calculated by a simple sum - assets minus liabilities. We also call the difference between these figures equity, or in public sector organisations they’re sometimes known as reserves.

These accounting categories refer to how we measure the value of new wealth that an entity creates in a period. Income is an accounting concept that relates to the creation of value, especially by selling goods and services to the market, but also by other means. For example, income can be obtained by earning interest on financial capital that has been lent to others and by making profit from the sale of assets that have been bought at a cheaper price. The term expenses deals with the consumption of that value.

For example, expenses occur when an entity uses raw materials to produce finished goods, when it employs labour in exchange for salaries and wages, and when it consumes an asset like a car or a building to carry out its operations. Profit is the difference between income and expenses.

Indeed, if the profit is positive, then the entity has created more value than has been consumed in a period. It has created new net wealth. On the other hand, if the entity consumes more value than it creates, then expenses will be higher than income. And the difference between the two results in a loss of the net wealth of the entity. Businesses ultimately aim to make a profit and to increase their wealth. Public sector entities do not aim to make profit by their statutory mandate. However, they lose part of their wealth if they make a loss.

Cash flow is the difference between the flow of cash payments received by an entity and the flow of cash payments made by the entity in a period. Cash inflows originate, for example, from the sale of goods and services, from the sale of assets and from the borrowing of money. Cash outflows relate, for example, to the payment of salaries and wages, to the payment of interest on borrowed capital, and to the payment of dividends to shareholders. Cash flow reflects a change of the amount of cash that an entity owns.