bAs a small business owner, you need to wear every single hat including “Chief Financial Officer.” But don’t let that responsibility intimidate you. Since your business is small, it is relatively easy to balance your books as long as you are fully aware of six essential financial terms that have the biggest impact on your finances.
Whether you’re planning to start a business or you’re already at the helm of a small operation, it’s important that you have a solid understanding of the financial lexicon. To give you a nudge in the right direction, here are 6 financial terms that every small business owner should know:
In the financial world, an asset is anything your company owns that holds value within the context of your operation — it could be an amount of money, a building, or even a trademark. An asset can be tangible (physical), like a piece of equipment, or intangible (non-physical), like a widely-recognized brand. The more assets you own, the stronger the foundation of your company becomes because they return value to you while bolstering your emergency reserve.
I just mentioned that assets bolster a company’s emergency reserve, and that’s because most assets hold redeemable value in the general business world. If it becomes necessary to raise funds to make it through a crisis, certain assets can be sold off to keep the company afloat while it charts a course back to stability. Liquidity is a measure of how easily a given asset can be offloaded at the standard market price, and the more liquidity you have, the more easily you can respond to emergencies. Note that even desirable properly lacks liquidity, because property sales take a lot of time to go through.
Accounts payable (A/P) and accounts receivable (A/R) are the sums of the amounts of money owed to clients and owed by clients, respectively. These sums need to be meticulously tracked because they’re majorly impactful — the former counts as a liability, while the latter counts as an asset. All business transactions should be formally recorded through comprehensive invoices.
Cash flow is simply the aggregate of the funds moving in and out of a business within a set period (usually a month, but it could be a week instead if useful). Once you tally up your A/P and your A/R, subtract expenses, and add in any other sources of funds, you either have positive cash flow (more coming in than going out), which is stable, or negative cash flow (more going out than coming in), which is unsustainable. Business owners can fixate on profit instead, but that’s a mistake: you can survive a lack of profit, but you can’t survive negative cash flow. Read all about cashflow in our other blog post.
It’s very common for a small business to rely heavily on a few big clients (or even just one big client). Winning a large number of clients requires a lot of time, effort, and resources, so it isn’t something that a small business can realistically achieve. This is fine to begin with, but it’s ultimately dangerous — when you draw most of your venue from specific clients, they hold too much influence over your fate. Concentration is a measure of how well your business is divided across clients. The less concentrated you can make it, the more stable your company will be.
To operate and grow, a business needs to make money. This is obvious enough, but getting pricing right is a challenge. Ask for too much and you drive people away, but ask for too little and you not only don’t make enough money but also devalue your brand. That’s why markup is mission-critical. It describes the amount added to the full cost of a product (research, development, production, etc.) to make resulting sales profitable. Supposing it cost you $10 to design, produce and sell a piece of clothing, and you sold it for $15, you’d have a $5 markup.
These 6 financial terms are important to know because they significantly affect the long-term viability of your business. If your operation is too concentrated, your markups are too small, and you don’t have enough assets, then you’ll struggle — and if you run into negative cash flow, you won’t be able to endure. Consider these terms carefully, plan accordingly, and you’ll have a strong chance to survive (and thrive).
Kayleigh Alexandra is a content writer for Micro Startups — a site dedicated to spreading the word about startups and small businesses of all shapes and sizes. Visit the blog for the latest micro biz news and inspiring entrepreneurial stories. Follow us on Twitter @getmicrostarted.