Most small businesses are started by entrepreneurs that are experts in their industry. However that does not necessarily mean that they are up-to-date on all aspects of running a business. One of the necessities to achieve a successful business is an understanding of the various financial terms that are associated with profitability of a business, as well as needed in tax preparation. These terms will be used time and time again, so it is important for all new business owners to learn what they mean and how they apply to running their business.
- Assets. Anything that a business owns that has monetary value can be considered an asset. This includes physical items such as equipment, inventory and buildings as well as monetary forms of cash, such as bank accounts and accounts receivable.
- Liabilities. The counter balance to assets is liabilities, which is anything that is monetary that a business owes. This can be loans, credit cards, and accounts payable; all monies owed to someone else.
- Capital. Working capital is the amount of assets or monetary value a business has to run day-to-day operations. The simple equation for capital is to subtract all liabilities from assets, giving you the balance. The capital ratio is calculated by dividing assets by liabilities.
- Cost of Goods Sold. CGS or cost of good sold is a common term used in business. This is used to calculate profit and revenue so it is a very important term. For retail, it can be calculated monthly by adding value of beginning product inventory to any product purchased during the month, then subtracting the end of month inventory. This will give the value of CGS.
- Expenses. All costs related to running a business, also called overhead, can be considered expenses. This includes rent, utilities, payroll, marketing, taxes and transportation costs.
- Profit. The most important term for most business owners is profit. The total amount of revenue brought in by a business, minus expenses and CGS is the profit.
- Profit and loss statement. Most businesses should be calculating their profit every month. A profit and loss statement tallies the revenue, CGS and expenses, giving the profit for the period.
These terms will be used when discussing loans, taxes and even investment opportunities, so all business owners should be familiar with their meanings. They are also the basic building blocks to learning how to determine profitability and analyze what areas need to be enhanced to increase profit. By understanding these basics, new business owners can move toward building a successful company.
