Regardless of what your business entails, there is one thing that all companies have in common, and that is money. Even a non-profit business has to track their funds. Some business owners embrace handling their finances, and others would rather avoid responsibility. Wherever you may fall on this spectrum, all business owners need to understand some basic financial terms. This knowledge is critical when talking to your accountant or a lender.
To get you started, here are 20 basic financial terms.
Accounting – the process by which financial information about a business is recorded, classified, summarized, and interpreted.
Accounts Payable – the amounts your business owes to your creditors for goods or services received.
Accounts Receivable – the amounts owed to your business by clients or customers for provided goods or services.
Accrual Basis Accounting – this is one method of accounting that you can use to run your business. It recognizes revenues and expenses at the time of the sale, not when the cash is actually received or paid out. This method requires the double-entry method of accounting. When you enter a transaction in one account, you also enter a matching transaction in the other account (Accounts Payable and Accounts Receivable).
Assets – the cash value of everything a company owns and uses to conduct business. These are usually classified as current or fixed. Current (or short-term) assets include cash or inventory. Fixed (or long-term assets) include equipment or land.
B2B versus B2C – An overall description of your business customer. If you primarily do business with other businesses, then you are a business-to-business (B2B) venture. If you supply a product or service to a consumer (end user), then you are a business-to-consumer company.
Cash-basis Accounting – An accounting method that records revenue when cash is received (not when invoiced), and expenses when they are paid. Accounts receivable and accounts payable do not come into play under the cash-basis system.
Cash Flow – the movement of money in and out of your business. You want a positive cash flow – when the flow of income is greater than the outflow of expenses.
Depreciation – the degrading value of a fixed asset over time.
Fiscal Year – the 12-month accounting period used in your business. The fiscal year can coincide with the calendar, but it isn’t necessary. Your fiscal year could run July to June, or October to September. A company is responsible for choosing their fiscal year start and end dates.
Fixed Cost – costs that do not vary during a period, even if business volume is greater or less than anticipated. An example of a fixed cost would be a lease or rent payment.
Gross Profit – simply the difference between the revenue generated from sales and the cost of goods sold.
Liabilities – debts your business owes to others. Like assets, there are two types of liabilities: short term (current) and long term (fixed). Short term expenses are financial obligations that are due within one year or within a normal operating cycle, such as money owed to suppliers. Long term debts extend beyond a year or the normal operating cycle of a business, such as a business loan.
Net Loss – when your total expenses exceed your overall income. The risk of a net loss is one of many reasons to understand the financial side of your business and to keep company costs under control.
Net Profit – also known as your “bottom line.” Net profit represents total revenues minus total expenses. For some businesses, this figure is especially important at tax time because you pay self-employment taxes as a percentage of net profit.
Operating Expenses – normal expenses incurred in the running of your business.
Profit Margin – how much profit a business keeps relative to total sales. It is expressed as a ratio of profit divided by revenue and displayed as a percentage.
Variable Cost – expenses that change in proportion to the activity of a business. This can include raw materials used in manufacturing, utilities, and commissions paid.