In order to be successful, every business owner, manager, and director needs to understand finance basics. At some point, you will find yourself in a discussion which uses specific financial terms, and you need to comprehend the language.
This article will simplify those sometimes puzzling but need-to-know financial terms. Learning the common jargon used and what each word means is an excellent first step.
Financial Terms Cheat Sheet:
Company money you owe to your vendors and suppliers. Accounts payable arise when you purchase something on credit and receive an invoice from the supplier. For instance, an invoice for janitorial services or an invoice for one hundred new uniforms that you purchased for resale.
The money customers owe to the company. 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. This is done on a non-cash (credit) basis, in which the customer promises to pay in the future.
Spreading the costs of intangible assets over time, rather than expensing them all at once. See the definition of intangible assets. Amortization is similar to depreciation, which spreads the cost of tangible assets over time.
Things that the company owns, such as cash, fixed assets, inventory, and accounts receivables.
A financial statement that shows assets, liabilities, and owner’s equity. While a profit and loss (P&L) statement covers a specified period (usually a month or year), a balance sheet is a statement of a specific date, such as December 31.
Cost of Goods Sold (COGS)
The cost associated with the goods sold during a given period.
Cash (and/or assets easily converted to cash) within one year of the balance sheet date, also known as liquid assets. Some examples would include cash, accounts receivables, short-term investments, and inventory.
Company liabilities that must be paid within one year of the balance sheet date. These include accounts payable, wages payable, and loan payments due in the next twelve months.
One of the measurements of a business’s financial strength 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.
Allocating the cost of tangible fixed assets over the time period in which they are utilized. For instance, 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 many years.
Earnings Before Interest, Taxes, Depreciation, and Amortization also known as Operating Profit. This is net revenue minus operating expenses.
Non-current assets that a company uses to generate income also known as Property, Plant & Equipment (PP&E). For example, fixed assets include buildings, real estate, equipment, and furniture. In addition, these are tangible assets that benefit the company for periods of time greater than one year and are depreciated over their life.
The total of all sales during a period prior to returns, discounts, and allowances.
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. In addition, goodwill is not amortized, while other intangible assets are.
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.
Things that the company owes to others such as accounts payables, wages to workers, taxes to government agencies, and loans.
Total assets minus liabilities 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 would include when a family of three joins a Martial Arts studio. For instance, you sell three uniforms for $50 each and grant a $10 family discount. You bought the uniforms for $25 each. Your gross sales would equal $150 and your net sales would equal $140. In addition, your cost of goods sold was $75, so your net revenue is $65.
Net Sales (or Revenue)
Gross sales minus returns, discounts, and allowances.
The money a company spends daily in order to operate. Categories for labeling operating expenses include:
- 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.
Assets minus liabilities. On every balance sheet, assets equal liabilities plus owner’s equity. 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 the retained earnings below.
Profit and loss statement or income statement. The profit and loss statement shows a company’s revenue and expenses over a given time period, typically a month, a quarter, or a year.
The sum of all profits and losses since the business opened.
Working capital is similar to the current ratio, as it is a measurement of your business’ liquidity. To calculate working capital you take current assets minus current liabilities. Working capital is measured as a dollar figure, while the current ratio is a percentage.
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