ACCOUNTS PAYABLE (A/P)
Money you owe to vendors/suppliers for products or services they've provided but you haven't paid for yet.
This is your short-term debt to suppliers. You'll need cash to pay this soon (usually within 30 days). Shows up as a liability on your balance sheet.
Example: You received $10K worth of inventory and got a $5K bill from your lawyer. You haven't paid either yet. Your A/P is $15K.
ACCOUNTS RECEIVABLE (A/R)
Money customers owe you for work you've done or products you've delivered but haven't been paid for yet.
High A/R means you're profitable on paper but broke in reality. You've done the work but haven't collected the cash. It's an asset on your balance sheet, but it's not spendable until they pay you.
Example: You invoiced three customers for $25,000 this month. None have paid yet. Your A/R is $25,000.
ACCRUAL BASIS
You count income when you invoice customers (not when they pay). You count expenses when you receive bills (not when you pay them).
Example: "Let's say you have a customer and you've sent them an invoice for $1,000, and you got a bill from a paper company for $250. You haven't gotten the money yet from the customer and you haven't yet paid that bill to the paper company. Your accrual basis income is $750."
This shows what "reasonably happened" during a time period, even if cash hasn't moved. Gives a more accurate picture of business performance because you're expecting to get paid and you're expecting to have to pay.
ACCRUED EXPENSES
Recording an expense you know about but haven't been billed for yet (or haven't paid yet).
Example: December 28, you know you're paying $10K in bonuses. December 31, you record (accrue) the $10K expense. January 15, you actually pay the bonuses.
When this becomes important: In accrual basis accounting. You must match expenses with when they were actually incurred (when the work happened), not just when you paid them. This way your P&L shows the true cost of operations for that period.
Common examples: Year-end bonuses earned in December but paid in January, utilities for the month you won't get billed for until next month, property taxes you know are coming.
ADJUSTED GROSS INCOME (AGI)
Your total income minus specific things the IRS lets you deduct right off the top.
What you can deduct to get AGI:
-
- Retirement contributions (401k, IRA, SEP)
- Self-employed health insurance
- Student loan interest
- Teacher classroom expenses (up to $300)
- HSA contributions
Example: You made $150,000 total income. You contributed $10,000 to retirement and paid $8,000 in self-employed health insurance. Your AGI is $132,000.
*Many tax benefits phase out at certain AGI levels. Lower AGI = more tax breaks you might qualify for.
AMORTIZATION
Same concept as depreciation, but for intangible assets—things you can't physically touch like software, patents, trademarks, or goodwill from buying a business.
The difference: "Physical tangible asset (truck) versus not a physical tangible asset (software, trademark) is typically the rule."
Two types you'll see:
1. Software: "Computer software gets amortized because it's going to burn out pretty fast. The IRS says it's worth 3 years. So you have 3 years that you're amortizing that." Example: Buy $12,000 software, amortize $4,000/year for 3 years.
2. Goodwill (buying a business): "You buy a business for $1 million. Part of what you bought was physical assets (desks, computers). But a lot of it is intangible—the customer relationships, the reputation. That's called goodwill. The IRS says that gets amortized over a 15-year period."
Small business reality: "Most software today is under the IRS limits, so you can write it off immediately. You won't see ongoing amortization for most small business clients."
ASSETS
Anything your business owns that has value.
What counts:
-
- Cash in the bank
- Money customers owe you (accounts receivable)
- Inventory
- Equipment
- Vehicles
- Buildings
- Prepaid expenses
Helpful way to remember: If you own it and it has value, it's an asset.
BALANCE SHEET
A snapshot of what you OWN (assets), what you OWE (liabilities), and what's LEFT (equity) at a specific point in time.
Think of your house: "If you bought a $500,000 house with a $400,000 mortgage: Asset = $500,000 (the house), Liability = $400,000 (the mortgage), Equity = $100,000 (what you actually own)."
Important connection: "The change in your balance sheet from one period of time to the next IS your income statement. They're connected."
Key point: Shows the financial health of your business right now. Are you building wealth or drowning in debt?
Helpful way to remember: Unlike a P&L which covers a time period (like a video), a balance sheet is like taking a photo - it's true as of that exact moment.
BOOK VALUE
What an asset shows on your balance sheet (usually the historical cost minus depreciation).
Example: You bought a building 10 years ago for $300K. Book value on balance sheet today: $200K (after depreciation). Market value today: $500K (what you could sell it for).
Why you should care: Your balance sheet shows book value, not market value. This is why balance sheets can understate the true value of your assets.
CASH BASIS
You only count income when money hits your bank account. You only count expenses when money leaves your bank account.
Same example as accrual: "You sent an invoice for $1,000 (not collected) and got a bill for $250 (not paid). Your cash basis income is $0 because no actual cash moved. You have not collected any money and you've not paid anything out, so your net profit is zero on a cash basis."
Why use it: Simpler. Matches when cash actually moves. Can provide tax advantages for some businesses.
Important note: "Most small businesses file taxes on cash basis even if they use accrual for their own bookkeeping. We present books on accrual basis (better for decision-making) but adjust at tax time if you're cash basis taxpayer."
CHART OF ACCOUNTS (COA)
The master list of "buckets" for every dollar in and out of your business. Think of it like your filing system—but someone else organized the files.
Why it feels backwards: "It's organized for tax forms and GAAP (Generally Accepted Accounting Principles), not for your decisions. Categories like 'Cost of Goods Sold' vs. 'Operating Expenses' make sense to accountants, not business owners."
Common frustrations:
-
- "Why is my web designer in 'Professional Fees' but my lawyer in 'Legal & Accounting'?"
- "I have 47 expense categories but can't see what I actually need to track"
- "Your accountant set it up 5 years ago and you've been stuck with it ever since"
This is the foundation of ALL your financial reports (P&L, balance sheet, everything). If it's set up wrong, everything feels confusing.
CLOSING THE BOOKS
Making sure everything is accurate and complete before calling the month "done."
What's involved:
-
- Reconcile all bank accounts and credit cards
- Enter missing transactions
- Make journal entries for depreciation, accruals, corrections
- Review for errors
- Double-check everything makes sense
Why it takes time - LEGITIMATE reasons:
-
- Waiting for bank statements to finalize
- Chasing down missing receipts from you
- Complex transactions need research
- Multiple accounts to reconcile
Why it takes time - BS reasons:
-
- They're just slow/disorganized
- You're not a priority
- Their process is inefficient
Red flag vs. Green flag: Red = 3+ weeks consistently, blames you, no communication. Green = 5-7 days, proactive requests, explains delays.
COGS (COST OF GOODS SOLD)
All the costs involved in the product or service you're selling, mainly product.
This is the first number you need to know to understand if you're making money on what you sell.
Baseball glove example: "You paid $5 for it. In that $5, there could be $3 in materials (leather, thread) and $2 of labor costs to actually make the glove. That $5 total is your COGS."
Restaurant: COGS = food costs + beverage costs + kitchen labor. NOT your manager's salary or rent.
Service business (plumber): COGS = pipes, fittings, and the technician's time on the job. NOT your office manager or truck insurance.
This is the first number you need to know to understand if you're making money on what you sell.
CURRENT ASSETS
Assets you can turn into cash pretty quickly—within 12 months.
What counts:
-
- Cash in the bank (already IS cash!)
- Accounts Receivable (customers will pay soon)
- Inventory (you'll sell it and get cash)
- Prepaid expenses (benefit coming soon)
Why "current" matters: Shows your short-term liquidity. Can you pay your bills in the next few months?
Healthy business: Has enough current assets to cover current liabilities.
CURRENT LIABILITIES
Debts you need to pay soon—within 12 months.
What counts:
-
- Accounts Payable (vendor bills due in 30 days)
- Credit card balances
- Current portion of loans (this year's payments)
- Accrued expenses (bonuses, taxes owed)
- Customer deposits (work you haven't done yet)
Key point: You need cash to pay these SOON.
Key metric: Current Assets vs. Current Liabilities—can you cover what you owe?
Example: Current Assets $50K, Current Liabilities $45K → You're good. Current Assets $20K, Current Liabilities $45K → Cash flow problem coming.
DEDUCTIBLE EXPENSE
An expense the IRS allows you to subtract from your income. Think of it like a coupon—it reduces the taxable amount by a percentage.
How much it saves: Depends on your tax bracket. $1,000 deduction in 25% bracket = $250 tax savings.
Common deductible business expenses:
-
- Office supplies
- Business meals (50%)
- Business mileage
- Equipment
- Employee wages
- Rent
Explained: "Hopefully one of the privileges of working with an accountant is you have somebody in your corner trying to help you reduce your tax bill."
DEPRECIATION
Spreading the cost of a big purchase over multiple years instead of expensing it all at once.
Explained: "Even though you paid for it today, accounting rules say you have to spread that expense over the 'useful life' of the asset."
The $50K truck example: "You buy a $50,000 truck and pay cash. Real money left your account—you feel that pain immediately. But the IRS says trucks have a 5-year useful life. So you can only deduct $10,000 per year for 5 years. Each year, you'll see $10K in 'depreciation expense' on your P&L even though no money left your account that year. The $50K already left back when you bought it."
THIS IS WHY YOU FEEL BROKE EVEN WHEN YOUR P&L SHOWS PROFIT.
More examples:
-
- Restaurant buys oven for $30K cash → Shows as $6K expense/year for 5 years
- Home services buys truck for $45K → Shows as $9K expense/year
- Healthcare buys equipment for $50K → Cash gone, P&L shows $10K expense this year
The disconnect: "You feel broke because you just spent $50K, but your accountant says 'it's only a $10K expense this year.'"
The good news: "Section 179 and Bonus Depreciation let you write off more (or all) immediately for tax purposes. Ask your accountant about this when buying equipment!"
How long things depreciate:
-
- Rental property: 27.5 years
- Commercial building: 39 years
- Trucks/vehicles: 5 years
- Most equipment: 5-7 years
DIRECT LABOR
Labor used to produce the product or deliver the service.
Explained: "In that $5 baseball glove cost, if $2 is labor, that's the person physically sewing the glove together. That's direct labor."
Pool service company: Technician at customer's house servicing pools = direct labor. Person answering phones = NOT direct labor.
Key point: Part of your COGS. Goes up the more you sell.
DUE DATES
The date by which payment or filing is required.
Explained: "One of our teammates put 'due dates' on the list of confusing accounting terms because clients legitimately don't understand what 'due date' means sometimes."
Common due dates:
-
- Tax returns: April 15 (or October 15 if extended)
- Quarterly estimated taxes: April 15, June 15, September 15, January 15
- Monthly financial close: 5-7 days after month-end (good accountants)
- Vendor payments: Usually 30 days (Net 30)
The confusion: "When are taxes due?" April 15 for filing, but you should pay quarterly estimates throughout the year.
EBIT (EARNINGS BEFORE INTEREST AND TAXES)
Same concept as EBITDA, just without the depreciation and amortization part.
Explained: "You're going to see variations—EBITDA, EBIT, sometimes EBITDAO (adds back owner expenses). They're all trying to show operational profit in different ways."
EBITDA (EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION, AND AMORTIZATION)
Explained: "It's just an acronym. Why isn't it IBITDA (Income before...)? Nobody knows. It's just accounting world stuff."
Earnings before interest, taxes, depreciation, and amortization get taken out.
The idea behind it: "This is the true cash in and outs of my business."
-
- Taxes = byproduct of your profit
- Depreciation/Amortization = capital expenditures from prior periods
- Interest = cost of money you borrowed
Real talk: "Warren Buffett says it's a useless data point. He's got billions of dollars, so he probably knows more than we do."
Why accountants use it: Trying to show operational profit versus non-operational stuff.
EFFECTIVE TAX RATE
Your actual average tax rate—what percentage you really paid.
Formula: Total tax paid ÷ Taxable income
Example: Taxable income $100,000, actual tax paid $13,600 = 13.6% effective rate.
Explained: "Even though you're 'in the 25% bracket,' you only paid an average of 13.6%."
The difference:
-
- Marginal rate (bracket) = tax on your NEXT dollar
- Effective rate = average tax on ALL your dollars
Key point: This is your real tax rate. Much more useful than knowing your bracket.
EQUITY
What's left after you subtract everything you owe from everything you own.
The formula: Assets - Liabilities = Equity
House example Explained: "If you bought a $500,000 house with a $250,000 mortgage, your equity is $250,000. The bank owns $250,000, you own $250,000."
Mike explained it: "If I bought a $500,000 house and I got a $500,000 loan, I don't own anything. There's no equity. I have zero equity. But if I only took out a $250,000 loan, then the bank owns $250,000 and I own the other $250,000. That's my equity piece."
Key point: This is YOUR stake in the business. Growing equity = building wealth. Shrinking equity = losing ground.
FIXED COSTS
Expenses that stay the same whether you sell 1 unit or 1,000 units.
Explained: "Rent: $5,000/month whether you sell $10,000 or $100,000 worth of product. That's fixed."
Other fixed costs:
-
- Insurance
- Salaried employees (salary doesn't change based on sales)
- Loan payments
- Software subscriptions
Key point: "Fixed costs are your 'break-even hurdle.' You have to generate enough revenue to cover these before you can make any profit. High fixed costs = higher risk."
FLOW-THROUGH ENTITY
Business structure where income "flows through" to your personal tax return. The business itself doesn't pay taxes—you pay the tax on your personal return.
Flow-through entities:
-
- Sole proprietorship
- Partnership
- S-Corporation
- LLC (usually, depends on tax election)
Example: Your S-Corp made $100K profit. The S-Corp pays $0 in tax. That $100K shows up on YOUR personal tax return. YOU pay the tax.
Vs. C-Corporation: C-Corp pays its own tax on profit, then you pay tax again when you take dividends. "Double taxation."
Key point: Most small businesses are flow-through. You might pay tax on business profit even if you didn't take all the cash out.
GOODWILL
When buying a business, the intangible value beyond physical assets—customer relationships, reputation, brand.
Explained: "You buy a business for $1 million. Part of what you bought was physical assets (desks, computers). But a lot of it is intangible—the customer relationships, the reputation. That's called goodwill. The IRS says that gets amortized over 15 years."
GROSS PROFIT / GROSS PROFIT MARGIN
The gap between what something costs you and what you sell it for. What's left after you subtract cost of goods sold.
Explained: "This is one of the metrics you absolutely have to know if you're a business owner. On the macro level, you need to know it. In a service line, you need to know it. On a product by product basis, you probably need to know it."
Baseball glove example: "You buy it for $5, you sell it for $25. Your gross profit is $20."
Key point: If your gross profit is too low, you'll never cover your rent, insurance, admin staff, and overhead—no matter how much you sell.
Most businesses: Should aim for at least 30% gross margin, but depends on your industry.
INCOME (TAX TERM)
On your tax return, there are multiple types:
Explained:
-
- Interest income: Money earned on a bank account
- Capital gain income: "You bought stock at $10, sold it for $20, made $10—that's a capital gain"
- Business income: Net profit from your business that's taxable
- Wage income: W-2 from an employer
- Dividend income, rental income, and others
All these get added together to get "Total Income." Then you start taking deductions.
INCOME STATEMENT
See P&L (Profit & Loss Statement)—they're the same thing.
ITEMIZED DEDUCTIONS
Instead of taking the standard deduction, you can add up specific things the IRS allows:
What you can itemize:
-
- Mortgage interest
- Property taxes (up to $10K)
- State income taxes (up to $10K)
- Charitable contributions
- Medical expenses (over 7.5% of AGI)
Explained: "You compare your itemized total to the standard deduction and take whichever is greater."
Example: Standard deduction = $28,000. Your itemized deductions = $35,000. You'd itemize because $35K is higher.
JOURNAL ENTRIES
Adjustments that don't come from regular transactions. Accounting entries made to record things or fix things.
When accountants make journal entries:
-
- Recording depreciation (no transaction happened, just an accounting entry)
- Recording accruals (expense you know about but haven't been billed for)
- Fixing errors
- Reclassifying transactions to correct categories
Example Explained: "You know you're going to owe a $5,000 bonus in December but won't pay it until January. We make a journal entry to record the $5,000 expense in December (when it was earned) even though you haven't paid it yet."
Part of the month-end close process.
LIABILITIES
Anything you owe to someone else.
What counts:
-
- Bills you haven't paid yet (accounts payable)
- Credit card balances
- Loans
- Mortgages
- Accrued bonuses (you know you'll pay but haven't yet)
- Customer deposits (money they paid for work you haven't done)
Key point: Liabilities are claims against your assets. More liabilities relative to assets = riskier position.
House example: "If your $500K house has a $490K mortgage, the bank owns almost all of it. That's risky."
LONG-TERM ASSETS
Assets you're keeping and using for the long haul. Also called "Fixed Assets" or "Property, Plant & Equipment (PP&E)."
What counts:
-
- Buildings
- Land
- Equipment
- Vehicles
- Furniture/fixtures
- Long-term investments
Key point: Shows what you've invested in to run the business long-term. These typically get depreciated over time.
Restaurant example:
-
- Building: $500K (long-term)
- Kitchen equipment: $100K (long-term)
- Food inventory: $10K (current)
- Cash: $20K (current)
LONG-TERM LIABILITIES
Debts you don't have to pay off in the next 12 months.
What counts:
-
- Mortgages (minus this year's payments)
- Equipment loans (minus this year's payments)
- Long-term business loans
- Deferred taxes
The split: "If you have a $100K equipment loan, this year's payments ($20K) = current liability. Remaining $80K = long-term liability."
Key point: Shows your overall debt load. Too much can be risky, but it's less urgent than current liabilities. Some long-term debt is normal (mortgages, equipment), but equity should be growing over time.
MARGINAL TAX RATE
See Tax Brackets. Your marginal rate is the rate on your LAST dollar of income, not your average rate on all income.
MARKET VALUE
What you could sell something for today.
Explained: "You bought a building 10 years ago for $300K. Book value on balance sheet: $200K (after depreciation). Market value today: $500K (what you could actually sell it for)."
Truck example: "Bought truck for $50K five years ago. Book value: $10K (after depreciation). Market value: $25K (what you could sell it for)."
Key point: "When someone's buying your business, they care about market value, not book value. Balance sheets can understate true asset values because they use historical cost, not current market value."
MATERIALITY
Is it enough to actually matter? Would knowing this detail change any decision you'd make?
From the podcast - telephone example: "Thinking back 15 or 20 years ago, we used to have long distance charges, a monthly bill, and mobile phones. I don't need to see all three on my income statement. I need to see 'telephone.' Am I going to make a decision to not have phones? I think materiality is going, am I going to make a decision based off that number? If the answer is probably no, then it's not material."
Another example: "You spent $300 all year on something. You want this to be a specific line. I could lump it in office supplies or miscellaneous. You're not making a decision off that number. It's such a small speck. It doesn't matter."
Key point: You and your accountant need to be on the same page about what matters. Don't drown in details that don't affect decisions, but do track things that drive decisions.
The tension: "Everything is material to an accountant sometimes. Or the opposite—everything could be material to the business owner."
Coffee at $300/year? Not material—lump into office supplies.
Marketing at $30,000? Material—break out Google Ads vs. Facebook Ads vs. Direct Mail.
Explained: "We're talking about $300 and you spent $400,000 on food in your million-dollar restaurant. How do we get your food costs down? Because that's the bigger problem."
NET INCOME
All of your income minus all of your expenses. What's left at the very bottom line. Hopefully money you're taking home as the business owner.
Explained: "It is all of your income minus all of your expenses. Hopefully this is the money that you are actually taking home. It's the very, very bottom line."
Restaurant example: "Your restaurant brought in $100,000. After paying for food ($30,000), labor ($40,000), rent ($10,000), and all other expenses ($15,000), your net income is $5,000. That's what's left."
Key point: If this number's negative, you're losing money. Track it monthly.
NON-DEDUCTIBLE EXPENSE
Expenses that do NOT reduce your taxable income.
From the podcast - THE BIG MISCONCEPTION: "It is a misconception to think that 'I own a business, therefore anything that business buys reduces my taxable income so I pay less in tax.'"
Just because you used your business card doesn't mean it's deductible.
Non-deductible business expenses:
-
- Entertainment (sporting events, concerts)
- Personal expenses (even if on business card)
- Family vacation (even if on business card)
- Credit card interest (personal)
- Fines and penalties
Real example from podcast: "If you decide you want to take your family on a vacation to the Grand Canyon for a couple of weeks and all you're doing is hanging out, just because you use your business credit card doesn't mean you get to not pay taxes on that vacation cost. That is a non-deductible expense."
But: "You spend airfare and hotel to go to a business conference? That IS deductible."
Why accountants ask questions: "This happens a lot around meals, travel, automobile usage. A portion used for personal = non-deductible. A portion used for business = deductible. We're asking to help determine if you can reduce your income for those expenses."
OPERATING EXPENSES
Expenses to run the business that aren't directly tied to making/delivering your product or service.
Explained: "Most fixed costs are in operational costs. That's insurance, rent, utilities, your administrative person who's not involved in sales."
Not part of COGS. These are your overhead costs.
P&L (PROFIT & LOSS STATEMENT)
Also called Income Statement or Statement of Revenue and Expenses—they're all the same thing.
A report showing all income you earned and all expenses you paid over a period of time (month, quarter, year).
Explained: "Think of it like a video recording. You hit record, it captures everything that happens, then you stop it. A P&L captures all the financial activity over that time period."
Key point: This is your business scorecard. It tells you if you made or lost money.
Fun fact: "A client once asked us 'What is a P N L?' They meant P&L—Profit and Loss."
The difference from balance sheet: "P&L = video (what happened over time). Balance sheet = photo (status right now)."
PREPAID EXPENSES
You paid for something now that you'll use/consume over time.
Common examples:
-
- Insurance (pay $12K for full year in January)
- Rent (sometimes pay first/last month upfront)
- Annual software subscriptions
- Retainer fees
How it works:
-
- January: Pay $12,000 for annual insurance
- Balance Sheet: $12K "Prepaid Insurance" (asset)
- January P&L: $1K "Insurance Expense"
- Each month: Move $1K from prepaid to expense
- By December: Prepaid is gone, all $12K expensed
Key point: Even though you paid $12K in January, we spread it over 12 months as $1K/month expense. Gives you more accurate monthly P&L.
REALIZED GAIN
You sold the asset and locked in the profit. You pay tax on this.
Example: Bought stock at $10, sold at $20 → $10 realized gain. Now you pay tax.
Real estate: House worth $500K when bought, sold for $700K → $200K realized gain. Now you pay tax (though there are home sale exclusions).
Business: "Your business is worth $2 million" → Unrealized (no tax). Sell for $2 million → Realized (now you pay tax).
RECONCILIATION
Matching your bank/credit card statements to what's recorded in your books. Making sure everything is accurate and complete.
What's involved:
-
- Checking: Did we record everything?
- Matching: Does what we recorded match what left the bank?
- Finding: Are there mystery transactions?
Key point: Part of why it takes time to "close the books." Catches errors, fraud, missing transactions. Ensures numbers are actually accurate.
Real scenario: "Your books show $50K in expenses. Bank shows $55K left the account. There's $5K missing—we need to find it and record it."
STANDARD DEDUCTION
The IRS gives every person an automatic deduction off their AGI. No hoops to jump through.
Explained: "Everyone gets this automatically."
Amounts (change yearly with inflation):
-
- Single: ~$14,000
- Married filing jointly: ~$28,000
- Head of household: ~$21,000
You choose: Standard deduction OR Itemized deductions (whichever is greater).
Most people take standard because it's higher than their itemized deductions.
TAX BRACKETS
Explained: "The rates are progressive. Your taxable income gets taxed at different rates as it fills up different 'buckets.'"
How it actually works:
-
- First $20K → 10%
- Next $60K → 12%
- Next $20K → 22%
- Above that → 25%
"I'm in the 25% bracket" means: NOT that you pay 25% on everything. Your LAST dollars are taxed at 25%.
Example:
-
- $0-$20K @ 10% = $2,000
- $20K-$80K @ 12% = $7,200
- $80K-$100K @ 22% = $4,400
- Total tax = $13,600 (13.6% effective rate)
Explained: "Basically, you jam all that income into different piles. When one pile fills up, you move to the next pile until you get to your rate."
Helpful way to remember: You're not "in" one bracket—your income moves through multiple brackets like filling up buckets.
TAX CREDIT
A dollar-for-dollar reduction in the tax you owe. Think of it like a gift card to pay your tax bill.
Explained: "Credits are WAY better than deductions."
How much it saves: $1,000 credit = $1,000 tax savings. Period. Doesn't matter what bracket you're in.
Example: Tax bill is $15,000. You have $2,000 child tax credit. New tax bill: $13,000. That's $2,000 cash in your pocket.
Refundable vs. Non-refundable - Mike's Costco example: "I think about refundable tax credit as my Costco rebate. With my Costco card, they give me a percentage of whatever I paid. That gift certificate is basically cash. I can take it to Costco and say 'I don't want to buy anything, give me cash' and they will. That's the refundable credit. The Earned Income Credit is refundable."
Non-refundable: "Once you're at zero tax, the credit can't reduce it further. That gift card only lets you pay the bill—they're not giving you extra cash back."
Explained: "We like tax credits. Try to get all the credits you possibly can. Even non-refundable ones—the government is giving you money to use in the future."
TAX DEDUCTION
An expense the IRS allows you to subtract from your income. Think of it like a coupon—reduces the taxable amount by a percentage.
How much it saves: Depends on your tax bracket.
Example: $1,000 deduction in 25% bracket = $250 savings. Same $1,000 in 12% bracket = $120 savings.
Real scenario: Pay $10,000 mortgage interest (deductible if you itemize). In 25% bracket = $2,500 tax savings.
Common deductible business expenses:
-
- Office supplies
- Business meals (50%)
- Business mileage
- Equipment
- Employee wages
- Rent
Helpful way to remember: Deduction = coupon (percentage off). Credit = gift card (dollar for dollar).
TAXABLE INCOME
Your AGI minus either standard deduction or itemized deductions (whichever is greater). This is what you actually pay tax on.
The formula:
-
- Adjusted Gross Income (AGI)
- Minus: Standard OR Itemized Deduction
- Equals: Taxable Income
Example: AGI $132,000, Standard deduction $28,000, Taxable Income $104,000.
You pay taxes on $104,000, not $132,000.
This number goes into the tax brackets.
TOTAL INCOME
Add up all the different types of income on your tax return:
-
- Interest income
- Capital gains
- Business income
- Wage income
- Rental income
- Everything else
That's your total income. Starting point on your tax return. Then you subtract things to get to AGI.
UNREALIZED GAIN
You still own the asset, but it's worth more on paper. No tax until you sell.
Example: Bought stock at $10. Stock now worth $20 → $10 unrealized gain. No tax yet.
Real estate: House worth $500K when bought. Now worth $700K → $200K unrealized gain. No tax until you sell.
Explained: "Your business is worth $2 million" → Unrealized (no tax). Sell it for $2 million → Realized (now you pay tax).
USEFUL LIFE
How long the IRS says an asset will be useful, which determines how many years you depreciate it over.
Explained:
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- Rental property: 27.5 years
- Commercial building: 39 years
- Trucks/vehicles: 5 years
- Most equipment: 5-7 years
- Software: 3 years
VARIABLE COSTS
Expenses that go up or down based on how much you sell.
For example: The leather that goes in a baseball glove—that's going to increase as you sell more gloves. The amount of time it takes to make those gloves—that's going to increase your labor cost (direct labor)."
Other variable costs:
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- Materials/supplies
- Direct labor (hourly workers)
- Sales commissions
- Shipping costs
- Credit card processing fees
Key point: Variable costs should stay a consistent percentage of revenue. If they don't, something's wrong with pricing or efficiency.
The utilities example: If you're in a production world or making something, you may have an increase in your utility bill because you're using more utilities to make the thing. Utilities in that case would be variable. But office utilities that don't change? Fixed.
Explained: "Most variable costs will be in your gross profit (COGS). Most fixed costs are in operational costs."
Helpful way to remember: Fixed = same every month. Variable = changes with sales volume.
