That entrepreneurial spirit of yours is at the heart of your success. But it’s your financials that will help you keep your business (and spirit) alive. One of the areas many entrepreneurs drop the ball is in their approach to or lack of accounting know-how and more importantly focus.
We want you to be able to focus on the things you love about your business, but we know you need to stay on top of your finances. These 10 accounting terms will help you set a firm foundation to build on.
An asset is anything you own outright with monetary value. Your inventory, your business vehicles, your real estate and even your office furniture help make up your assets. You should also add on a few sub-terms to help define your assets including:
- Fixed: which are assets that aren’t so liquid and are held over the long term such as land.
- Current: which are assets that can be turned into money fast such as the obvious cash, but also in some cases your inventory or even some investments.
- Tangible: the assets you can touch such as equipment.
- Intangible: the assets you can’t touch like a patent for your product or copyrights to your books.
A liability is basically a debt whether it’s a balance on your credit cards, a bank loan or outstanding bill payments to suppliers. Current liabilities should be paid back within a year while long term liabilities would be more substantial and can be paid back over longer terms.
Equity is the remaining value of an owner’s interest in a company, after all liabilities have been deducted. You may hear of equity being referred to as “stockholders’ equity” (for corporations) or “owner’s equity” (for sole proprietorships). Equity can be calculated as: Equity = Assets – Liabilities.
4. Bottom line
The bottom line gets its name quite honestly. It refers to the overall profits that appear at the bottom of your income statement. Pretty logical. So, if your small business accounting service says, “this is going to eat into your bottom line,” listen to them as that means it can decrease your profits. Your bottom line is the number that reflects your current financial results.
5. Cash flow
Cash flow is how money moves in and out of your company. To track it you look at the money in your bank at the start of a certain period and the balance remaining at the end of that period.
You want to maintain a healthy cash flow as it helps you avoid the need to use credit or borrow money for your day to day operations. High cash flows go beyond the break-even mark allowing you to invest more in your business and help you create personal financial success
6. Gross margin
Gross margin is the revenue minus the expenses directly needed to earn those revenues. For example, a construction business would take their earned revenue less job materials and labor costs to get the Gross margin. This gross margin money covers your normal business towards your overhead, like rent and payroll. It also should cover your personal wages and the profit required to make your investment work for you.
7. Capital expenditure
Capital expenditure refers to money invested in an asset that provides ongoing benefits. This would be something like your vehicles, equipment and other large expenditure that should provide earning capacity over several years.
8. Working capital
Working capital measures the short-term financial health of your business. The formula used to calculate working capital is current assets – current liabilities. This measures the ability of your cash to cover the ongoing commitments of the business.
9. Costs of sales
This is the cost associated with the production of a product. You’ll have fixed costs which include the items that never change in the production process as well as variable costs which include costs that might fluctuate. Variable costs are harder to predict and are related to the volume of activity. Some common examples of variable costs might include:
- Direct materials
- Direct labor
- Transaction fees
- Utility costs
- Billable labor
Concentration focuses on what percentage of business your company conducts with a particular client or group of clients. Ideally, you have several large clients or a variety of groups of clients to reduce the risk to your business with one significant loss.
When one large client makes up a large percentage of your revenue, if that client leaves it could be difficult to reduce costs quickly enough to avoid a traumatic blow to the business.
Concentration can bring efficiencies but can also efficiently wipe out the business. Review client make-up regularly to redistribute that risk to give your working room should a change occur.
These 10 accounting terms are fundamental for entrepreneurs to know to have valuable conversations with their CPA or accounting coach.
With our Business Compass Program we work with you to set the financial foundation of your business so you can thrive. Our proven process and accountability meetings teach you how to track your financial activity so you can make financial decisions in real-time.
Schedule your free 30-minute Introductory Call to learn more about how our program can be the beginning of true financial control and health.
Visit our Entrepreneur’s Guide to Accounting for more valuable articles like this one to help you build the right foundation for your business financials.