Whether you are starting out as an entrepreneur or a seasoned CEO, there are certain financial terms which are essential for you to know. They will not only help you in discussions with your financial advisor but they can benefit you when you speak to your colleagues, an investor or a potential client. Here are ten basic financial terms you should know:
Assets are anything that the company owns that has monetary value. This could be land, vehicles, inventory, cash, furniture, accounts receivable, patents and copyrights to name a few. Assets can be divided into four categories: Fixed, current, tangible and intangible.
- Fixed assets are things which can’t be converted into cash quickly and are purchased for long term use e.g. land and buildings.
- Current assets are things which can be changed into cash quickly like inventory, cash and investments.
- Tangible assets are things which you can touch. An example is a machine.
- Intangible assets are things which you cannot touch like patents and copyrights.
When we talk about liabilities, we are looking at any debt which the business has since it was started. This can be credit card debt, money owed to suppliers and bank loans. Liabilities can be divided into current and fixed.
- Current liabilities refer to debt which must be settled within a year and is normally related to your suppliers
- Fixed liabilities refer to the debt which is settled over more than one year like a bank loan.
3. Bottom line
This refers to the final figure at the bottom of the income statement. It refers to the overall profit of a company. You may have heard the phrase “affecting the bottom line” and this refers to things which increase or decrease the profits of a company.
4. Gross Margin
The gross margin refers to the percentage of the sales earnings that a company keeps after the costs for producing product or service are deducted. This percentage is then used to pay for overheads like rent, salaries and more.
5. Costs of sales
This is what the raw materials and production process costs. This can be divided into fixed costs and variable costs. Fixed costs refer to items which do not change no matter how many products you produce. They are very easy to calculate. The variable costs will change depending on how many products you produce and they are harder to forecast.
The equity refers to the ownership one has for a company. Equity can be sold to investors who will then have a share in your business. In accounting terms,
Equity = assets – liabilities, this calculation will give you the market value of your company.
7. Cash flow
This refers to the movement of money through your business every month. You can determine your cash flow by looking at your cash balance at the start and end of a certain period.
8. Capital expenditure
This is a purchase which will continue to give you benefits beyond the taxable year that it has been purchased in. Examples are computers and property to name a few.
When we look at concentration, we are considering what percentage of business your company is doing with the clients in your business. If you do business with a one or a few clients, then this is considered overconcentration and can pose a problem to your business.
10. Working capital
The efficiency and the short term financial health of a company can be measured through working capital. To calculate working capital, you can use the following formula:
Working capital = current assets – current liabilities.
Furthermore, you can use a working capital ratio (current asset/current liabilities) to see if a company can pay their short term debts. If the ratio is below one, it is seen as negative and anything above 2 shows that you are not investing enough of the capital. A ratio between 1.2 and 2 is consider a good place to be with regards to working capital.
By learning these terms, you will be less confused when you speak to the finance gurus in your business circle.
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