Many aspiring entrepreneurs experience setbacks in their pursuit of business ownership because while they may be well versed and talented in their specific craft, they are not so versed and informed on the business side in order to maintain and sustain a thriving business. Below you will find key business terms defined. Most of these terms are accounting terms used to create the financial books (balance sheet, income statement and cash flow statement) for your business. Accurate and timely financial statements are critical in order to monitor the financial health of your business. They are also needed to secure financing for your business. The more informed you are about how to manage the day-to-day operations of a business, the better positioned you will be to grow and sustain your business.
Accounts payable is the money you owe vendors for services rendered. For example, if you are a clothing designer you may have relationships with fabric providers. If the fabric company supplies you with inventory prior to receiving actual payment, you will carry an accounts payable on your book of records. This keeps tracks of the liabilities (bills) that you owe others. Typically, you should try to keep accounts payable under 90 days, but this may vary depending upon the type of industry you operate within. When searching for bank financing, bankers will sometimes look very carefully at businesses that carry accounts payable beyond 30-90 days.
Assets refers to your business’ cumulative financial holdings. These are usually classified as current assets (can be liquidated fairly quickly but typically less than a year), or fixed assets (assets that will take longer than a year to liquidate). Current, or short-term assets include cash, marketable securities, accounts receivable or inventory. Fixed, or long-term assets, include equipment, building or land. Although not necessarily a fixed assets, long-term assets may also include some long-term investments.
Liabilities are debts your business owes another person or entity . Like assets, liabilities are categorized as current or long-term. Current, or short-term liabilities include accounts payable (defined above) and current maturities of long-term debt. Other short-term liabilities may include payroll to employees. Long-term liabilities, on the other hand, include business loans that have maturities greater than one year. Many business loans are considered long-term liabilities. You could also have short and/or long-term tax liabilities, franchise fees, etc. Typically you want more assets than you have liabilities. This shows potential creditors that you have the financial wherewithal to weather ups and downs within your business. Entrepreneurs that have a higher risk of failure places a high level of liabilities (debt) on their balance sheet. What in the banking world is terms as “leveraged.” Higher leveraged borrowers have a more challenging time securing business loans because they do not have the assets (collateral) to secure the risk of the debt.
Revenue (sales) refers to the income you get from from your business activities, measured monthly, quarterly, and annually. You can calculate revenue by multiplying the per-unit cost of goods or services sold by the quantity of units sold during each specific time frame. Revenue is usually shown on the income statement. Businesses need to generate a sufficient level of revenue over their expenses (discussed below) to receive a profit. If expenses outpace revenue generation, the business will lose money and eventually fold due to cash flow and liquidity issues.
Expenses includes recurring and/or one-time costs that are required to do business. Cost of goods sold (the price needed to create your product), rent, utilities, insurance, payroll are all categorized as expenses. These are all examples of expenses—money you spend to operate your business. To maintain a sustainable business, you want to ensure your expenses do not outpace your revenue. Revenue and expenses are noted on the Income Statement.
Also known as your “bottom line.” Net profit represents total revenues less total expenses. This figure is especially important at tax time. This is because you pay taxes as a percentage of net profit.
If your total expenses exceed your total revenues, you have a net loss. The risk of a net loss is one of many strong reasons to keep company costs under control.
This basic business term measures how much profit you keep relative to total sales. There are three types of profit margins: gross, operating and net. Calculate these by dividing the profit (revenue minus costs) by the revenue.
Cash flow is the movement of money in and out of your business. You want there to be a higher flow of income into the business than there is an outflow of expenses from the business. This is called a positive cash flow.