One of the main reasons why businesses don’t make it, won’t grow, are stagnant and entrepreneurs fail at their endeavors, is a lack of knowledge of basic business finances. Just because you don’t have an accounting degree or finance degree is no excuse for failing at business! Anyone can be the CFO (Chief Financial Officer) of their business. In fact, entrepreneurs and business owners should be the CFO until they can afford to hire help. You’ll know the ins and outs of how your business’ finances work and be in a better position when time to turn that role over to someone else.
So here are what I believe to be six key financial concepts every entrepreneur and business owner should know:
Business income is generated from the sale of products and services. It is the money received received in exchange for the product your business sells or the service provided. A critical point to note is that Income and Net Income (Profit) are two different things. Income is gross sales before any expenses are deducted. Net Income is the profit the business keeps after expenses and other costs to run the business are paid. Understanding the relationship between Income and Net Income is key in being able to keep a business up and running.
Expenses are the costs to run a business. Every business will have them. The idea that you can effectively and efficiently operate a business without having to spend money is erroneous! A business has to spend money in order to make money. Examples of expenses include (but are not limited to) supplies, advertising, taxes, rent or lease, wages, etc. All these costs are subtracted from the income generated from sales of products and services, and what is left over is Net Income. The goal is to operate a successful business at the least cost possible.
3 Net Income
You want your bottom line to be in the black (positive), not red (negative)! Net Income – income minus expenses, is a representation of how the business performed during a specific period of time. Income, Expenses and Net Income make up one of the common financial statements for a business: Profit and Loss Statement.
Assets are everything a business owns. They are typically categorized as Current, Fixed and Other Current. Current Assets consist of cash and cash equivalents (assets that can be converted to cash fairly quickly). A couple examples are money in bank account and accounts receivable. Fixed Assets include property and equipment: buildings, land, furniture and fixtures, machinery and vehicles. Other Current Asset examples are prepaid expenses and inventory.
Liabilities are everything a business owes. Liabilities are categorized as Current, Other Current and Long Term. Current Liabilities are paid within one year. An example is accounts payable, amounts owed to vendors and suppliers. Other Current Liabilities are loans payable, sales tax payable and payroll taxes payable. Long Term liabilities would be amounts paid over a longer period of time, longer than one year.
Equity represents the value of a business. Don’t get Equity and Net Income confused though, they are not the same! Equity is the difference between the accumulation of assets and accumulation of liabilities since inception of the business. You may hear terms like Owners Equity and Retained Earnings to describe Equity. It doesn’t matter how much Net Income is generated during a particular period of time because if it’s not managed properly or invested back into the business effectively, it will have a negative impact on the value of the business. Assets, Liabilities and Equity make up another key financial statement: the Balance Sheet.
So there you have it…the key concepts entrepreneurs and business owners should know about business finances. Now, this was far from Accounting 101 class but you have a general idea of important financial data. Take this knowledge, expand on it and learn how you can boost your business’ profits and ultimately increase its’ value!