Back to School for Small Business Owners: Business Finance Terms 101

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It’s the start of the new school year for everyone from kindergarteners to graduate students. Why not you? You may have been out of school for a little while, but it’s never too late to learn – some of the most successful business owners are those who are constantly learning. You’re an expert in your company’s field, so it’s understandable if basic business terms aren’t top of mind. Learning financial terminology can not only help you better understand your business’s financial health but can also help when it comes to meeting with your accountant, bank or lenders. Here are a few terms to study (but don’t worry, there won’t be a test).

Asset

The first of many basic business terms you’ll want to remember is an asset: anything your business owns that supports operations and has some inherent cash value. Examples of assets include cash on hand, land, buildings, inventory or equipment. An asset can be current (short-term) or fixed (long-term), depending on its life cycle. Stock holdings and product inventory are considered current assets because they can be converted to cash within one fiscal year, whereas equipment is a fixed asset because it will serve the company over many years.

Liability

A liability is the opposite of an asset. It’s something your business owes or is legally bound to pay. Debt is one type of liability, and accounts payable (better known as your bills) is another. Like assets, liabilities can be short-term or long-term. As an example, accounts payable are short-term, and a mortgage is long-term.

Balance Sheet

There are a few basic business terms associated with the balance sheet you’ll want to pay attention to. A balance sheet is a financial statement that shows the balance between what you own (your assets), what you owe (your liabilities) and what you have left over once you subtract your liabilities from your assets (known as your owner’s equity, net worth, or working capital). Although banks and other financial institutions look at your income statement, they typically pay the most attention to your balance sheet. Why? Well, the balance sheet is similar to your personal financial statement. It shows your business’s net worth, the amount and type of debt you have (short-term or long-term) and what assets you have to use as collateral if the loan calls for it.

A business owner reviews a book on basic business financial terms

Cash Flow

Cash is the lifeblood of your business. Since you need cash to pay your bills, without it, your business could fail in no time. Cash flow is how much cash flows in and out of your business during a given time frame, such as a week or a month. “Positive” cash flow means more money came in during the week, for example, than went out. “Negative” cash flow means the exact opposite — more went out than came in that week.

How quickly your customers pay greatly impacts your cash flow, so it’s important to consider a customer’s payment history before you continue to extend them credit. It’s equally as crucial to make sure they repay you according to your stated terms, so “10 days” means they pay in 10 days. Sure, those situations can get awkward, when you’re torn between maintaining a positive relationship with your customer and nudging them to pay up but keep your eye on the prize — predictable cash flow and a smoothly run business.

Net Profit

Your net profit is what your business has left over after paying all of its bills. Your business generates sales revenue, then pays for all the employees, materials and supplies. After that, you must pay rent, utilities, advertising and more. Then you pay taxes. Whatever remains after everything is paid is your net profit or net income. Net profit is sometimes referred to as “the bottom line” (another basic business term you will hear a lot) because it appears on the bottom line of the income statement.

Accounts Receivable

If you run the kind of business where clients pay after products or services are delivered, accounts receivable is incredibly important. It’s a running record of all the money owed to your business, including the amount, the client and the number of days past due. Tracking this information helps stay on top of collecting debts while providing a legal basis for your entitlement to payment. Typically, accounts receivable is recorded as an asset on the small business balance sheet. Collecting debts is rarely easy, so it helps a lot to have accurate, up-to-date records about all outstanding debts.

Profit & Loss

This is another one of the basic business terms used to describe your financial performance, similar to the income statement. Every business spends money in order to make money, but if costs exceed revenues, the business won’t last long. Profit and loss is a record of all the profit you make compared to the unexpected losses you incur. For example, if you make a product for $5 and sell it for $20 your profit is $15, but if two of your products are stolen, your loss is $10. Lenders will ask to see profit & loss statements to evaluate the health of your business before approving financing.

Business Credit Score

One of the first steps every entrepreneur should take is setting up a business credit score separate from your personal credit score. This ensures your business has a separate credit score that doesn’t impact your personal credit. You don’t want to mix your personal and professional finances. Plus, you may be able to borrow more if your business score is higher than your personal score. Scores are based on the information in your business credit report (another one of the basic business terms worth knowing), which includes the size of the operation, the number of years in business, any legal fillings, and credit history, among other things. All this information is then run through an algorithm that calculates your business credit score based on a scale from 0-100 (the higher the better). Lenders will look closely at this score when making financing decisions.

Credit Limit

At some point, you’re likely to open up a business line of credit. When you do, lenders will determine your financial risk (largely based on your business credit score) to determine how likely you are to repay any debts. Based on their conclusions, they will extend a line of credit up to a specified credit limit. The limit is the amount you can borrow before the credit cuts off. A credit limit can be an obstacle for your business if you need to borrow more, in which case a small business loan might be a better option. In any case, improving your business credit score helps you raise your credit limit.

There are many other basic business terms, but these few are a good place to start. If you’d like more financial homework, check out our resource on business loan terms, and Entrepreneur provides a glossary of tax terms as well.

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