Every business owner, manager, and director needs to understand the basics of finance in order to be successful. At some point you will find yourself in a discussion in which certain financial slang will be used and it’s important for you to comprehend the language. This article will simplify those sometimes puzzling, but need-to-know, financial terms. This will be a good first step in learning the common jargon used and what each term means.
Accounts Payable — The monies owed by your company to your vendors and suppliers. Accounts payable arise when you purchase something on credit and receive an invoice from the supplier. Examples would be an invoice for janitorial services or an invoice for one hundred new uniforms that you purchased for resale.
Accounts Receivables — The monies owed to the company by its customers. It’s an asset sometimes referred to as A/R or debtors. Accounts receivables are the result of selling goods or services to a customer on a non-cash (credit) basis in which the customer promises to pay at some point in the future.
Amortization — Spreading the costs of intangible assets over time rather than expensing them all at once. See definition of intangible assets. Amortization is similar to depreciation which spreads the cost of tangible assets over time.
Assets — Things that the company owns such as cash, fixed assets, inventory, and accounts receivables.
Balance Sheet — A financial statement that shows assets, liabilities, and owner’s equity. While a profit and loss (P&L) statement covers a period of time (usually a month or year), a balance sheet is a statement as of a specific date such as December 31.
Cost of Goods Sold (COGS) — The cost associated with the goods sold during a given time period.
Current Assets — Cash (and/or assets that are easily converted to cash) within one year of the balance sheet date. Cash, accounts receivables, short-term investments, and inventory are the best examples. Current assets are also known as liquid assets.
Current Liabilities — Liabilities of a company that are to be paid within one year of the balance sheet date. These include such things as accounts payable, wages payable, and loan payments due in the next twelve months.
Current Ratio — One of the measurements of a business’ financial strength. It is calculated as current assets divided by current liabilities. Current ratio is used to measure a company’s ability to pay back its liabilities due in the near future.
Depreciation — Allocating the cost of tangible fixed assets over the time period in which they are utilized. For example, you buy exercise equipment for your facility. Rather than expensing the full cost in the year of purchase, you would place them on your balance sheet as fixed assets and depreciate them over a number of years.
EBITDA — (pronounced “ee-bit-dah”) Earnings Before Interest, Taxes, Depreciation, and Amortization. This is net revenue minus operating expenses. EBITDA is also known as Operating Profit.
Fixed Assets — Non-current assets that a company uses to assist in the generation of income. Fixed assets are also known as Property, Plant & Equipment (PP&E). Examples of fixed assets include buildings, real estate, equipment, and furniture. These are tangible assets that benefit the company for periods of time greater than one year and are depreciated over their life.
Gross Sales — The total of all sales during a period of time prior to returns, discounts, and allowances.
Goodwill — Goodwill is a type of intangible asset. It only arises when a buyer purchases another business from a seller and the amount paid is greater than the fair market value of the tangible assets purchased. Goodwill is not amortized while other intangible assets are.
Intangible Assets — Assets that are not physical in nature. Examples of intangible assets include patents, copyrights, trademarks, customer lists, non-compete agreements, and franchise agreements. The costs to acquire intangible assets are allocated to expense on the profit and loss (P&L) statement through amortization over the useful life or legal life of the asset, whichever is shorter.
Liabilities — Things that the company owes to others such as accounts payables, wages to workers, taxes to government agencies, and loans.
Net Assets — Total assets minus liabilities. Net assets is also known as owner’s equity.
Net Income (or Net Profit) — Operating Profit (EBITDA) minus interest, taxes, depreciation, and amortization.
Net Revenue (or Gross Profit) — Revenue minus the Cost of Goods Sold. An example of this would be when a family of three joins a Martial Arts studio. You sell three uniforms for $50 each and grant a $10 family discount. You bought the uniforms for $25 each. Your gross sales would be $150. Your net sales would be $140. Your cost of goods sold was $75, so that your net revenue is $65.
Net Sales (or Revenue) — Gross sales minus returns, discounts, and allowances.
Operating Expenses — The money a company spends in order to operate on a daily basis. Operating expenses may be labeled in categories such as:
- General & Administrative (G&A): This category includes executive salaries, professional fees, rent, insurance, utilities, legal services, and office supplies.
- Sales & Marketing (S&M): Costs to acquire your base of customers. Sales and marketing expenses include advertisements and lead generation.
- Research & Development (R&D) — The costs of activities used to develop new products, services, or knowledge. These costs are seen as investments in the future of the company.
Owner’s Equity — The difference between assets and liabilities. On every balance sheet assets equal liabilities plus owner’s equity. Owner’s equity is also known as net assets. It equals the owner’s investment in the business plus retained earnings. The owner’s investment is the net of any money the owner(s) put into or took out of the business. See definition for retained earnings below.
P&L— Profit and loss statement or income statement. The profit and loss statement shows the revenue and expenses for a company over a given time period. The time period is typically a month, a quarter, or a year.
Retained Earnings — The sum of all profits and losses since the business opened.
Working Capital — Working capital is similar to the current ratio as it is a measurement of the liquidity of your business. Working capital is calculated as current assets minus current liabilities. Working capital is measured as a dollar figure, while the current ratio is a percentage.