Not all entrepreneurs come prepared with a formal business education. In fact, many of the most successful small business owners are simply the ones who are truly passionate and knowledge about their industry. But despite the fact that you don’t necessarily need an MBA to be successful in business, do you need to know the basics.
This time of the year you’re probably going to be meeting with your account a little more frequently than normal, and without an understanding of basic financial terms, the conversations may be a little one-sided. To get you prepared for tax season, here are nine common financial terms that any business owner should know:
GAAP – Pronounced just like “gap”, GAAP stands for “Generally Accepted Accounting Principles” and are a collection of widely accepted methods for reporting accounting data. GAAP protocols make it easy to compare different businesses by using the same accounting guidelines for each.
EBITA – EBITA is short for “Earnings Before Interest, Taxes, and Amortization”. EBITA is a highly useful metric that allows your company’s performance to be effectively measured without taking into account expenses that are individual to each business and their capital structure.
Cash Flow – Cash flow is the measure of all money coming in and going out of your business during a certain period. It plays a huge role in measuring liquidity, as a business with poor cash flow – more money going out than coming in – will have a difficult time meeting financial obligations like rent and interest payments.
Net Income – Similar to profits, net income is commonly referred to as your company’s “bottom line”. It’s the total amount of income left over after you subtract all of the costs of doing business, as well as your business’ interest, taxes, and amortization expenses.
Gross Profit – Gross profit is a measure of how much money your company makes when providing a service or selling a product to your customers. For example, if you sold widgets for $75, and each widget cost you $50 to make, your gross profit would be $25.
Gross Margin – Your gross margin is basically a measure of gross profit expressed in percentage form, relative to your cost of purchasing or creating products, or providing services to your clients. For example, if your gross profit on a $75 widget sale was $25 after deducting the $50 the widget cost you to make, you’re gross margin would be 50%.
Fixed Costs – Fixed costs are expenses that are constant, regardless of how many sales you’ve made, during a set period. High fixed costs can be dangerous to a small company as they’ll be due no matter how slow or how busy business is. Common fixed costs include rent, vehicle and machinery payments, and employee salaries.
Variable Costs – Much less threatening to a smaller business or startup, variable costs are expenses that you incur relative to your level of production. Some of the most common variable costs will be raw production materials, sales agent commissions, and logistics costs.
Capital Expenditure – When you make a big purchase of a long-term asset for your company, that’s a capital expenditure. With a capital expenditure, the useful life of what you’re purchasing has to extend past the current year. Some common capital expenditures include heavy machinery, major office equipment, and even a new warehouse.
Armed with these nine basic financial terms, you’ll find that talking with your accounting will make a lot more sense – and provide a lot more insight into improving your business’ finances and profits as we continue to progress through 2015.
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