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As a business owner, you not only need to understand your customer, the market and how to sell your product or service, you also have to learn a whole new language of business terms. Here are 22 key financial terms you’ll come across often while running your business.
We’ve defined them in detail below, and we’ve made a handy-dandy guide to help you remember on the fly!
Accounts receivable: Quite simply, this is what you are owed. The work was done, you sent an invoice and now you’re awaiting the payment. On your balance sheet (see below), you include “accounts receivable” in the assets column.
Assets: The things your business owns. Tangible assets include computers, furniture, office supplies and your inventory. Intangible assets are any trademarks or copyrights you own. Both types of assets are part of your business’s total value.
Balance sheet: A key document for any business owner, this is a round up of the financial big three: assets (cash on hand, owner’s equity and any money still due to your business), liabilities (what you owe) and owner’s equity (the amount invested in the company by shareholders). The balance sheet represents the financial health of your business. Download a free balance sheet template.
Bottom line: There’s a good reason this term is used in everyday talk to mean the final, end-all, total profit or loss. The last figure on your ledger, this is the number that shows what your business had made or lost at the end of each month.
Break-even point: The equation that tells you how much money you need to make in order to recover the costs put into producing your product/service. First take the sales price (what your customers pay for your product/service) minus the variable cost per unit (what it costs to produce your product/service), then divide fixed costs (overhead, payroll, etc) by that number.
- Example: Lena makes artisan popsicles and her fixed costs are $600 per month to rent kitchen space, rent a farmer’s market booth and pay for marketing. She charges $4 for each pop which costs $2 in ingredients to make. So, $600 divided by $4 minus $2 (or $600/($4-$2) = 300). When Lena sells 300 pops during the month, she breaks even. Any sales beyond this are pure profit.
Capital: A fancy word that covers all the types of money you’ve earned or were given to operate your business - assets, cash on hand and investments. There are two types of capital to keep straight: debt and equity. Debt capital is money you have to pay back, like a loan. Equity capital is a share of your business profit in exchange for funds up front.
Cash flow: Like a never ending tidal cycle, this is the money that comes in and the money that goes out. Tracking your cash flow by week, month, quarter (or however you prefer) will give you a good idea of your long-term solvency, i.e. if you have enough funds to pay your monthly debts.
Cash flow statement: A cash flow statement captures all the money that’s gone in and out during a specific period of time and details on where it’s going to and coming from. Download a free cash flow statement template.
Cash ratio: Exactly like balancing your checkbook, this equation tells you how much cash you have on hand to pay your current liabilities. Your total assets are divided by your total liabilities. For this ratio, the higher the number the healthier your company.
Cost of goods sold (COGS): This equation, most often figured at the end of your fiscal year, year-end or any period of time that you track, tells you the cost of making/acquiring what you’ve sold. It’s determined by adding the value of your existing inventory at the beginning of the period/year to your purchased/manufactured inventory throughout the period/year minus the inventory left at the end of the period/year. This sum is considered a business expense. You’ll want to be as accurate as possible because the COGS goes on your business tax return and reduces your tax liability.
Debt-to-equity ratio: This is an equation that determines your ratio of liabilities to money invested. Simply put, it’s Total Debt / Total Equity.
- Example: Luis took out an $80K loan to start his business, and he also invested $10K of his own money. He’s since paid off $30K of his loan leaving $50K in debt, that added to his initial investment of $10k = $40k. So 50 / 40 = 1.25. Creditors contribute $1.25 for every $1 Luis contributes to his business. This figure is valuable for comparison over time and to potential new investors.
Depreciation: Just like when you sell your used car for less than you paid for it, this term applies to the waning value over time of your business assets like computers, vehicles, etc. Luckily, you can recover the cost of the depreciation with a tax deduction.
Expenses: The cost of doing business, baby! Some examples are your overhead (rent, utilities), payroll and marketing costs.
Financial report: This is where you can see a big picture of your business’ financial standings. Your financial report lets you, the owner, know how you’re doing, and it can also show potential investors the state of your finances.
Financial statement: If your financial report is your business casual lunch, then this is your black tie power dinner. More formal than a financial report, the financial statement is a detailed outlay of all your financial activities.
Income statement: This document shows how profitable your business is during a specific period of time. Also called a “profit and loss statement” or “P&L” this is simply your revenue minus expenses to produce the net income figure. Download a free income statement template here.
Liabilities: The debt you’ve incurred since starting your business up to the present. There are two main types of liabilities: “immediate debt” such as what you owe your suppliers and “long-term debt” such as bank loans or accounts payable.
Net income: This simple equation calculates all the sales you’ve made at the end of a period minus the cost of running your business (Profit - Expenses). At the start of a new business endeavor, this may be a negative number. If you consistently track it until it’s a positive number you know you’re making profit!
Owner’s equity: Very similar to the debt-to-equity ratio, this equation is figured by subtracting all your business liabilities from your total business assets. The answer is your equity or amount of ownership.
- Example: Jesse’s business is valued at $650,000 and he owes $100,000 in loans, plus he gave $200,000 in equity shares to investors. Jesse has $350,000 in owner’s equity.
Profit and loss: Synonymous with “income statement” as defined above, your P&L is simply what your business made and what your business spent during a period of time. When profits regularly exceed losses, you know your business is healthy.
Profit margin: This equation determines how much you’re actually making on what you sell. Take your net income (revenue minus expenses) and divide it by your total revenue to find the profit margin. A high profit margin indicates a financially fit company, while a low margin means it may be time to either lower your expenses or hike up your prices.
Valuation: A verb that describes the act of estimating what your business is worth overall by adding up property, assets, inventory and anything else that contributes to the value of your business. Do this to show potential investors or potential buyers what your business is worth.
Here’s a quick reference for keeping these important financial terms straight.
In the mood to read more about financial literacy? Check out these posts:
- Tool Kit: 7 Key Financial Equations
- Financial Literacy Basics When You’re Planning for Retirement
- Financial Literacy Basics When You’re Just Starting Out
- Financial Literacy Month Is Here!
- Bookmark this page so you can find all our financial literacy articles in one convenient place.
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QB Community members, what’s your go-to resource when you’re aiming to boost your own financial literacy?
