Every small business owner, from a retail store proprietor to a design agency founder, will need to handle finances in their lifetime. Whether or not you outsource finance to an accountant, it’s important you know some basic terminology and concepts surrounding finance:
Accounts Receivable: The money that is owed to a company or consultant by its clients or customers.
Amortization: Paying off a debt over time. The amount of money you owe is amortized as you continuously pay down the debt.
Annuity: A series of equal payments that are paid at a specific time each year for a specific number of years.
Assets: Anything owned by a company or individual that has monetary value. This can include “fixed” assets, such as property, vehicles or machinery, and can also include intangible assets, such as intellectual property.
Balance Sheet: Typically a monthly measure of a company’s financial health. Every month, companies reconcile the amount of revenue they generate with the amount of expenditures to determine their balance. This balance is then carried over at the start of the next month, where the revenue generated is added to the balance, and then the next month’s expenditures are deducted again. This is sometimes referred to as a rolling balance or carryover.
Bottom Line: This phrase has become so commonplace it’s almost cliché. The bottom line refers to the net amount of money your business earns after all expenses are deducted from your gross income.
Capital Expenditures: Any purchases you make for your business that will be useful beyond the year you purchased the item. This allows you to capitalize on the expenditure. Common types of capital expenditures are computers or manufacturing equipment.
Cash Balance: The amount of cash or capital you have in the bank at the start of an accounting period. In an organization with an ongoing balance sheet, this cash balance is typically carried over from one accounting period to the next.
Cash Flow Statement: This is a financial statement that is used to track the flow of capital into and out of a business during an accounting period. Cash flow statement analysis is key to understanding the economic stability of your company and should be evaluated frequently.
Concentration: Usually represented as a percentage, this is the amount of business you are doing with one particular client or partner. You are considered over-concentrated if you only rely on a handful of clients to do business with. This can seem risky to investors and may hurt the longtime viability of your company, since so much of your success is dependent on few clients. It’s better to have a larger base to draw from, so that the loss of a client will not devastate your business.
Equity versus Debt: Both of these terms refer to ways you may have gotten capital to start your business. Equity is money given by investors in exchange for a percentage of ownership in the company. Debt is the money you owe to lenders that must be repaid over time.
Fixed Costs: A fixed cost is one that doesn’t change, regardless of volume or other factors. Examples of common fixed costs are rent, internet, phone bills, salaries, etc.
Gross Margin: Normally a percentage, this number illustrates the total percent of sales revenue a company keeps after subtracting the cost of producing any goods or services.
Income Statement: A document that can be generated monthly or annually outlining the earnings of a company by stating all related profits and expenses incurred over the specified timeframe. Also referred to as a Profit and Loss Statement.
Initial Public Offering (IPO): This is the first sale of privately owned equity or stock to the general public. Also referred to as “going public.”
Leverage: In terms of business, leverage is simply the amount of money you borrowed to start your business. Being highly leveraged can be considered a high risk for investors, since you’ll need to make substantial repayments that could cut into your revenue for many years to come.
Liquidity: In business, this refers to how easily and quickly a company’s assets can be turned into cash; for example, stocks are considered fairly liquid.
Overhead: Indirect costs or fixed expenses required to run a business. These costs are not normally related to the production or sale of a good or service. Salaries, rent, utilities, etc. are considered “fixed costs” that are factored into business overhead. “Indirect costs” can include things like advertising, promotional offers, etc. These costs may vary month to month, but they are typically always a factor in your operating expenses.
Return on Investment (ROI): Refers to the quantifiable percentage return you receive from a certain investment. For example, if you spend $10,000 on advertising that generates $50,000 in sales, you gained $40,000 from your efforts and your ROI would be 400%. ROI can be measured by other less-tangible figures (i.e. quality over quantity), but for the sake of business, it is typically the bottom-line percentage amount companies are looking to measure.
Variable Costs: These are costs that change on a fairly regular basis and typically vary based on what a company produces. These types of costs are much harder to predict and prepare for.