Top 3 Bookkeeping Terms Every Business Owner Should Know

Bookkeeping can feel like a maze of numbers and jargon, but understanding a few key terms can make a huge difference in how you manage your finances. If you’ve ever glanced at your financial statements and wondered, What does any of this actually mean?, you’re not alone.

Let’s break down three essential bookkeeping terms - depreciation, net income, and retained earnings - in a way that actually makes sense for your business. 

Depreciation: Why Your Assets Lose Value Over Time

Depreciation is just a fancy way of saying that the expensive things you buy for your business (like equipment, vehicles, and machinery) lose value over time. If you buy a laptop today, it’s not going to be worth the same five years from now. That loss in value? That’s depreciation.

Since most business purchases are tax-deductible, the IRS doesn’t let you write off big-ticket items all at once. Instead, depreciation spreads the cost over multiple years. This keeps your financial statements accurate and helps you claim tax deductions year after year.

Example:

You buy a $10,000 piece of equipment, and it’s expected to last five years. Instead of deducting $10,000 in one year, you’d deduct $2,000 per year for five years.

Why It Matters:

• Helps lower your taxable income each year

• Gives a more realistic view of your business’s financial health

• Keeps your records clean when it’s time to sell or replace assets

If you’re not tracking depreciation, you might be overvaluing your business assets or missing out on tax benefits.

Net Income: The Number That Really Matters

Net income is your bottom line - the money left after you subtract all your business expenses from your revenue. It tells you if your business is actually making money or just breaking even.

Formula:

Net Income = Total Revenue – Total Expenses

Example:

You bring in $100,000 in revenue and have $60,000 in expenses (rent, payroll, software, etc.).

$100,000 - $60,000 = $40,000 Net Income

If you spend more than you earn, you’ll have a net loss instead of net income. And if you have a profit but never actually see extra cash in your account, it might be time to look at your spending habits.

Why It Matters:

• Shows whether your business is actually profitable

• Helps you make smart decisions about hiring, pricing, and expenses

• Banks and investors look at net income when deciding to lend you money

Watching your net income over time can help you figure out what’s working in your business—and what needs to change.

Retained Earnings: Keeping Some Profit for Growth

Retained earnings are the profits your business keeps instead of paying out to owners or shareholders. Instead of taking all your net income as a paycheck, some of it stays in the business to help it grow.

Think of it as a savings account for your business. You can use retained earnings to:

• Buy new equipment

• Cover slow months

• Invest in marketing

• Pay off debt

  
  

Formula:

Retained Earnings = Beginning Retained Earnings + Net Income – Dividends Paid

Example:

Your business starts the year with $50,000 in retained earnings. You make $40,000 in net income but decide to take $10,000 as a payout.

$50,000 + $40,000 - $10,000 = $80,000 Retained Earnings

Why It Matters:

• Gives you a cushion for unexpected expenses

• Helps fund business growth without taking out loans

• Shows financial health to banks and investors

If you’re constantly pulling money out of your business without reinvesting, it might be time to rethink your financial strategy.

Final Thoughts on These Bookkeeping Terms

You don’t have to be an accountant to understand your numbers - you just need to know what they mean for your business. Depreciation helps you track asset value, net income shows if you’re making money, and retained earnings help you grow sustainably.

If you’re ready to get a clearer picture of your finances, grab our DIY Bookkeeping Health Checklist. It walks you through the key areas we check when reviewing a client’s books - helping you spot red flags, avoid costly mistakes, and make smarter financial decisions.