As business owners, you might be tempted to spend 120% of your time with prospects, clients and writing business proposals to grow the business. But at times, it pays to review your financial numbers periodically and know where you stand as a business in terms of cashflow, margins and credit.
We spotted this piece originally published by Melinda Emerson that talks about key financial terms that every business owner shall have knowledge about, in order to make the best business decisions as you plan for cash flow, lending, and expansion.
Remember, operating a business is no different to driving a car, as Dawn Fotopulos says in his book “Accounting for the Numberphobic”. You shall regularly review your “financial dashboard”, which are your business’ balance sheet, income statement & cash flow statement to understand your business’ health and the direction it is heading to.
If you have a lean team and have been spending most of your time on operations and neglecting your numbers, it may payoff painfully as you’re looking to expand. Remember, bankers like to lend to businesses that can repay, and shows a clear cash flow in their operations, so are creditors, very much similar to a mortgage assessment.
So, we would strongly advise you to spare some hours to review the numbers with your team, and if time is tight, you may always outsource to a professional accountant for the numbers crunching part so you could stay focused on business while knowing your numbers!
KEY FINANCIAL TERMS YOU SHOULD KNOW
P and L — or “profit and loss” sheet is a report statement on how much profit (or loss) your business has made over a given period. Calculate P and L at the end of every month so you can spot trends early on.
Flash Report — in effect, an executive summary of your business finances, or a daily P and L report.
Balance Sheet — this shows the balance between your company’s assets and its liability. A balance sheet is a valuable financial snapshot that can assist in meaningful decision-making, especially if it is regularly tracked.
Assets — are all those things your small business owns in order to support operations. Assets include cash, real estate, land, equipment, tools, computers and furniture.
Liabilities — are all those debts your small business owes. Examples of liabilities include loans outstanding, bonds, and even the monthly bills your business owes.
Equity — is the money you (and any other owners) have invested into your business. In a sole proprietorship, equity is recorded in a capital account. If your company is incorporated, equity is expressed in terms of what percentage of the shares of stock are owned and their total value.
Bottom Line — may refer to net earnings or net income, depending on context. This term got its name from the typical location of the net earnings or income figure at the bottom of a company’s income statement.
Markup — is how much is added onto a business’s cost price of goods in order to cover overhead expenses and generate a profit.
Gross Margin — also known as “total cost of sales,” gross margin is the difference between total sales revenues and total cost of goods sold. It may be expressed on a per-unit basis, in dollars, or as a percentage. Higher gross margin means a company keeps more of each dollar generated by sales.
Gross Profit — is your sales figure minus your cost of sales. “Cost of sales” comprises the costs directly attributable to sales, such as materials, labor, and delivery.
Net Profit — is your total profit after all costs (e.g., including overhead, materials, wages) have been considered, but before dividends and taxation are calculated. Net profit is how much actual profit is being generated.
COGS — stands for “cost of goods sold.” It is the cost of the material and production of the goods a business sells. For manufacturers, COGS comprises materials, labor and overhead. For retailers, it is the cost to purchase inventory sold to customers.
CAPEX — stands for “capital expenditures,” which is the expense incurred to acquire any assets (e.g., machinery, office equipment) your business purchases to create future benefits. It is the expense of purchased assets that will be useful to the business beyond the tax year they’re purchased.
EBIT — means “earnings before interest and taxes,” and is self-defining.
EBITDA — means earnings before interest, taxes, depreciation and amortization. To calculate, take the gross margin and subtract total operating expenses, plus depreciation and amortization. While EBITDA subtracts all expenses, EBIT subtracts everything except depreciation and amortization.
GAAP — means “generally accepted accounting principles” and refers to rules and conventions for how financial information should be reported. It is a standardization of financial statements to ensure consistent reporting.
Revenue — refers to all the money your business collects from selling goods and services. A business may also amass revenue in other ways, like selling assets or interest and returns on investments.
Cost of Sales — is analogous to COGS for companies that sell services rather than goods. For a consulting company, the cost of sales includes compensation to consultants, research and administrative expenses, and costs for producing presentations and reports.
Retained Earnings — are company profits that are reinvested rather than paid out to the company owners.
ROI — is “return on investment,” represents a measure of profitability in relation to the money you have invested elsewhere. The calculation is (profits – investment) / investment.
ROA — “return on assets” is profit gained from a capital investment divided by the CAPEX cost. If you invested $1,000 on a piece of equipment, and it resulted in $1,250 in additional profits, you have an ROA of (1,250 – 1,000) ÷ 1,000 = 0.25, or 25%.
ROE — is “return on equity,” which is similar to the ROA and ROI calculations, except that your equity is the denominator.