A basic understanding of financial terms empowers business owners to manage their finances effectively, make informed decisions, secure funding, and ultimately run a successful business. It’s a fundamental skill that can make a significant difference in the financial well-being of a company.
Here are some fundamental financial terms that are essential for business owners to know:
Revenue: The total income generated by a business from its primary operations, typically from the sale of goods or services.
Expenses: The costs incurred by a business to operate and generate revenue, including salaries, rent, utilities, and supplies.
Profit: The amount remaining when expenses are subtracted from revenue. Profit indicates the financial health of a business.
Gross Profit: The profit earned after subtracting only the cost of goods sold (COGS) from revenue. It doesn’t include other operating expenses.
Net Profit: The profit earned after subtracting all operating expenses, including COGS, from revenue. This reflects the true profitability of the business.
Cash Flow: The movement of money in and out of a business, including income, expenses, and investments. Positive cash flow is crucial for business operations.
Balance Sheet: A financial statement that shows a business’s assets, liabilities, and equity at a specific point in time. It follows the formula: Assets = Liabilities + Equity.
Income Statement: Also known as a profit and loss (P&L) statement, it summarizes a business’s revenues, costs, and expenses during a specific period, showing its profitability.
Accounts Payable: The amount of money a business owes to suppliers, vendors, or creditors for goods or services received.
Accounts Receivable: The amount of money owed to a business by customers or clients for goods or services provided.
Working Capital: The amount of money available for a business’s day-to-day operations, calculated as Current Assets – Current Liabilities.
Capital Expenditure (CapEx): Money spent by a business to acquire, upgrade, or maintain long-term assets like equipment or property.
Depreciation: The allocation of the cost of a tangible asset over its useful life, reflecting its declining value.
Return on Investment (ROI): A measure of the profitability of an investment, expressed as a percentage of the initial investment.
Equity: The residual interest in the assets of a business after deducting liabilities, often representing the owner’s or shareholders’ ownership stake.
Liquidity: A measure of a business’s ability to meet its short-term financial obligations, often assessed using the current ratio (Current Assets / Current Liabilities).
Profit Margin: A percentage that represents the profitability of a business by comparing net profit to revenue. It can be gross profit margin or net profit margin.
Budget: A financial plan that outlines expected income and expenses over a specific period. It helps in managing and controlling finances.
Tax Deductions: Expenses or allowances that can be subtracted from a business’s taxable income, reducing the amount of taxes owed.
Break-even Point: The level of sales at which total revenue equals total expenses, resulting in neither profit nor loss.
Understanding these basic financial terms is crucial for making informed business decisions and managing financial resources effectively.
While understanding financial terms is valuable, collaborating with a CPA is a prudent investment into the well-being of your business. CPA’s bring a level of expertise, experience, and specialized knowledge that is indispensable for handling complex financial matters, ensuring compliance, optimizing financial strategies, and achieving financial success for businesses.
That’s where we come in.
At Aligned CPA, we help our clients understand their financial and empower them to thrive, grow and reach their goals. Become a client and see your dreams of owning and running a profitable and successful business become a reality.
Joy Lutz, CPA, CTP
Ready to feel confident about your financials? At Aligned CPA, our clients work with our firm on a monthly basis to have clarity on their accounting and financial position, peace of mind that they’re not overpaying in taxes, and support for their business growth decisions.