Financial Terms that Every Business Should Know
In order to start a business, you do not have to be financially savvy. You can hire an accountant or there are a number of accounting software that you can make use of. However, it is important that you understand the basics of finance. Following are some of the basic financial terms that you should be aware of, these terms may come up in meetings with clients, partners, and potential investors.
Balance sheet, income statement, cash flow statement, and financial statement
Described often as a snapshot of the financial conditions of a company, a balance sheet provides the financial balances of a business. It lists the assets, liabilities, and equity of the shareholders of a company at a specific point in time. Investors can look at the balance sheet and find out what the company owes, owns, and the shareholders' investment amounts. The assets of a company are calculated by adding the liabilities and the shareholder's equity. This is the formula that the balance sheet adheres to. If the company has taken any short term loans or long term loans, it will show up on the balance sheet.
Income statement or profit and loss statement shows the profit of a company during a specific period of time. A cash flow statement is used to track the expenses of a business. It also shows where the money came from. The main categories covered in a cash flow statement include financing activities, investing activities, operating activities, and supplemental information. A financial statement is a formal document, it lists all the financial activities of a business.
Assets, capital, liabilities, and depreciation
All the economic resources of a business come under assets. It can be anything tangible (fixed and current) or intangible (nonphysical resources such as trademarks, copyrights, software, goodwill, patents, and so on) that has an economic value. The assets of a business count towards its value. Capital is the money a company has in its accounts, investments, and assets. Equity and debt are the 2 major types of capital. Liabilities are what the company owes to banks, vendors, manufacturers, other financial institutions, and so on. Short term loans, long term loans, installment loans, credit card debts, all come under liabilities. The value of a company's assets can decrease after some time. This is termed as depreciation. Depreciation is tax-deductible.
Accounts receivable is the total amount a company is owed by its clients. It is shown as an asset on the balance sheet. If the debt owed by a client is not paid, it can be legally enforced.
Expenses and cash flow
The salary of the employees, operational costs, rent, utility expenses, advertising and marketing costs, all come under expenses. In short, all the business expenses come under expenses. The cash flow includes all the income and expenses, as well as any other funds that flowed through your company in a month. By comparing the cash balance available at the start and close of a specific period, the cash flow can be calculated.
Return On Investment (ROI)
ROI is a metric used by businesses to calculate the rates of return or profit. This will tell the business whether to go with an investment or not. 'Return' generally means profit before tax.
Valuation is basically the total worth of a business. If you want investors to fund your business, you will have to provide them with a valuation of your company.
It is important for a business owner to understand all the aspects of his/her business, including finance.