There are brilliant business leaders in today’s startup world, but while startups have their own, great talents, we’re seeing one similar area where entrepreneurs are lacking, which is understanding basic financial concepts.
Although these concepts behind these accounting terms are essential to the financial health and stability of a business, many first-time business owners and entrepreneurs are not necessarily familiar with the terminology.
Now I know, most entrepreneurs didn’t get into business to be accountants or bookkeepers- I sure didn’t; nevertheless, these terms and principles are a clear indicator of how well a company is doing and therefore should be understood on a basic level.
At the end of the day, this impacts long-term financial strategy as well as the ability to set up basic cost structures and within the company.
Even if you aren’t a finance major or don’t have one on your team yet, it is every chief executive’s responsibility to understand basic financial principles and how they can affect your business’ bottom line.
To help get all you new entrepreneurs started on the right financial foundation to ensure confidence from your investors and team, here are 16 basic finance terms that every good entrepreneur knows.
1. Assets and Liabilities
“Assets” are what add value to your company and increase your company’s equity, while liabilities decrease your company’s value and equity.
Assets include anything with monetary value that a company owns outright and that serves as a potential source of future financial benefit. For example cash, equipment, office space, inventory, vehicles, computers, etc.
“Liabilities” are anything related to money that a business owes, and that must be paid back in full. For example accounts payable, debt, notes payable, wages owed, etc.
2. Operating Expenses
“Operating costs” are the expenses associated with the maintenance and administration of a business on a day-to-day basis. For examples, these are costs incurred by a company through accounting and legal fees, bank charges, rent, phone bills, utilities, tax, and interest.
3. Equity vs. Debt
Many startup founders turn to outside funding to get their businesses going. “Equity” is ownership in your company; this is what you sell to investors in order to obtain the cash you need for operating expenses, equipment, etc.
“Debt” means borrowing money and not giving up ownership, this could be a loan from a bank that you must repay, with interest, at a later date.
4. Gross Revenue vs. Net Income
“Gross revenue” in simple terms, is revenue earned through sales, services and other means. Let me give you an example; if you sell a coffee for $5, your current gross revenue is $5, with the term gross meaning the total amount before subtracting such things as the cost of the coffee, the ingredients to make the coffee, the cup, and the staff to prepare and serve the coffee.
Thus, a company’s total gross revenue includes money earned through all of its product and service offerings. Taking it one step further, gross annual revenue consists of all of those sales from all of the products and services at the location over a full year. In short, it’s all the money your business earned over the course of a year.
“Net income” refers to money that remains after a business has paid its expenses. Net business income which is often referred to as the bottom line is a different figure altogether. This reflects what happens when costs come into play. To figure net business income, managers subtract all of the company’s associated costs. Not only are the espresso beans and the water for the coffee counted toward unit costs, but also the equipment used to grind the coffee, the salary of the person who prepared the drink, the cup it was served in, and so on.
Thus, net business income is what’s left over after companies pay their bills.
5. Gross Margin
“Gross margin” is a company’s total sales revenue minus its cost of goods sold, divided by total sales revenue, expressed as a percentage.
A higher percentage represents a higher amount a business retains on each dollar of sales.
6. Variable vs. Fixed Costs
A “Variable Cost” is a company’s cost that is associated with the amount of goods or services it produces. A company’s variable cost goes up or down, depending on the volume of sales. These costs include supplies and raw materials, sales commissions, the services of independent contractors, etc.
“Fixed costs,” stay the same regardless of how much you sell of your goods or services, even if no good or services are produced. These “operational costs” usually include employee salaries, business insurance, rent, utilities, insurance, advertising, and marketing.
The basic definition of “Depreciation” is something that goes down in value. Some, if not most, business assets decrease in value over time. An office computer, for example, loses value for each year of physical and operational deterioration. Accountants will use depreciation to assess the business expenses that can come out of tax obligations.
8. Cash Flow
“Cash flow” is the money that you generate and the amount spent during a given time frame, this money is moving (flowing) in and out of your business. Since it reflects the ability to pay operational expenses (based on how much cash a business has on hand), it’s a commonly used metric for the state of a business’s financial well-being.
9. Accounts Payable and Receivable
“Accounts Payable” are amounts a company owes because it purchased goods or services on credit from a supplier or vendor. Accounts payable are liabilities.
“Accounts receivable” are amounts a company has a right to collect because it sold goods or services on credit to a customer. Accounts receivable are assets.
10. Accounting and Bookkeeping
The terms “accounting” and “bookkeeping” are often interchangeable in the minds of business owners.
A bookkeeper records financial data. Bookkeeping is the process of recording daily transactions in a consistent way and is a critical component to building a financially successful business.
Bookkeeping is comprised of:
- Recording financial transactions
- Posting debits and credits
- Producing invoices
- Maintaining and balancing subsidiaries, general ledgers, and historical accounts
- Completing payroll
Accounting is a high-level process that uses financial information and data compiled by a bookkeeper or business owner and produces financial models utilizing that information.
The process of accounting is more subjective than bookkeeping, which is largely transactional.
Accounting is comprised of:
- Preparing adjusting entries (recording expenses that have occurred but aren’t yet recorded in the bookkeeping process)
- Preparing company financial statements
- Analyzing costs of operations
- Completing income tax returns
- Aiding the business owner in understanding the impact of financial decisions.
There’s some overlap from time to time, but entrepreneurs should understand the differences between these two services.
“Leverage” is a business term that refers to how a business acquires new assets for startup or expansion. Leverage is an investment strategy of using borrowed money. It is the use of various financial instruments or borrowed capital — to increase the potential return of an investment.
Please note, if you have way more debt than equity, you will be considered “highly leveraged” which can also be looked at as highly risky to potential investors.
12. Financial Report
A financial report is a written report of the financial condition of your company. It generally contains the summary of accounting data for that period, with background notes, forms, and other information.
13. Financial Statement
Similar to a financial report, a “financial statement” lists all of a business’s financial activities such as the balance sheet, income statement, statement of cash flow and statement of changes in net worth.
However, a financial statement is generally a more formal document, often issued by a lending institution.
14. Income Statement
“Income Statement” is a financial statement that reports a company’s financial performance over a specific accounting period, which is also known as a “profit and loss statement.”The income statement looks at a business’ revenues and expenses through all of its activities.
15. Balance Sheet
A “business balance” sheet gives an overview of the company’s financial situation at a given moment. Which reports the company’s assets, liabilities and shareholders’ equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure.
This includes the cash it has on hand, the notes payable it has outstanding and owner(s) equity in the business.
“Capital” is the money needed to produce goods and services. All businesses need capital to purchase assets and maintain their operations. Business capital comes in two primary forms: debt and equity.
It’s not necessary to be a financial wizard to succeed as a startup business. But not knowing basic financial terms could cause issues for entrepreneurs now or in the future.
The past few months, I have been reaching out to fellow entrepreneurs wanting to learn what pain points they are facing as they are on this journey of entrepreneurship. After seeing many similar pain points, we decided that the best way at DCN to help is by speaking on and creating more educational content covering business terminology, business 101, fundraising and more to help our network of growing entrepreneurs. Stay tuned for our next article as we discuss Convertible Equity And What Every Founder Should Know.
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