When it comes to running a business, knowing your numbers is one of the most important things you need to know. Without a good grasp of financial terms, you could be operating a glorified hobby and not a real business. Don’t let your fear of math be the reason why you don’t know what’s going on with the financial health of your enterprise. Profit margin is how we keep score in business. But before you can start counting any net earnings, you need to understand the 13 financial terms every small business owner needs to know.
- Assets – Anything with monetary value that the business owns such as cash, accounts receivable, inventory, etc.
Assets = Liabilities + Capital
- Liabilities – Debt of the business, accounts payable or any money owed by the business such as invoices to vendors, lease, bank loans or payroll.
- Capital – Capital is another word for money. Also referred to as Equity, capital means ownership, investment, stock, and retained earnings.
- Sales – An exchange of goods or services for money. Think of your sales as the engine that drives your business.
- Expenses – Overhead to run the business such as rent, marketing, utilities, accounting, legal, payroll, admin support, taxes, and interest.
- COGS – Stands for Costs of Goods Sold, also referred to as Direct Costs, means the raw material and labor costs associated with creating a product to sell, the cost of finished goods for resale or the cost of delivering a service.
- Gross Margin – the ratio of total (COGS) or direct costs to total revenue during a given quarter or year.
Sales – (COGS) = Gross Margin
- Profit Margin– how you determine the financial health of a business or the ratio of profits earned minus total sales receipts (or costs) over a given quarter or year.
Gross Margin – Expenses = Profit
- Burn rate – How much money it costs you to run your business each month, whether you are making money or not. It’s important to know your monthly burn rate so that you know how much money you need to keep in your cash reserves. It’s best to have at least six months of operating capital at all times.
- Breakeven Analysis – When your business’s expenses match your sales revenue. By developing a three-year sales projection will enable you to complete this analysis. This is a good indicator of whether or not you have a solid revenue model. It typically takes at least 12-18 months for a small business to break even.
Types of Financial Statements
- Income statement or Profit and Loss statement (P&L) – A financial statement, which shows sales, direct costs, expenses and profit over a period of time, such as a month or a year.
- The balance sheet – A statement that shows the business’s financial position at specific moment in time. It highlights assets, liabilities, and capital over a month or a year.
- Cash Flow Statement – Sources and uses of cash from one month to the other. You use this to evaluate your cash position in your business.
Now that you are armed with these financial terms, you should schedule a meeting with your accountant or CPA to discuss the financial health of your business. Remember, you should review your balance sheet, income statement, and statement of cash flows by the 15th of the month so that you can make any adjustments to your business operations or start making collection calls. Use up-to-date financial data to run your business better.