While a great idea for a product or a business can jumpstart your very own, it does not end there. Some famous entrepreneurs started in their garages, never having finished their degrees. They made it because of their revolutionary ideas, but they would never have made it big without having financial literacy.
Knowing how to handle finances is not just about preparing your tax returns and managing your books. Some aspiring entrepreneurs also need financial backing in order to start or to expand their businesses. In these cases, knowing how to present your business and your strategy for growth and profit is vital in getting people to invest in you and your company.
One of the first steps is understanding your financial concepts. There are, of course, many for you to acquaint yourself with, but starting with these seven will at least help you understand what your accountant or a potential investor are talking about.
“Affecting the bottom line” has to be one of the most common phrases out there when talking about a company’s financials. Basically, net earnings and net income fall under this description. In short, anything that affects the bottom line can either increase or decrease its earnings or profit. The history of this term is that at the bottom of the income statement is the profit, below the expenses and the revenues.
Gross margin shows the percentage of total sales revenue after removing the cost of production and other services. A high percentage indicates that the company makes more profit on the product, part of which will be used to pay other costs related to the operation of the business. For example, a gross margin of 25% means that for every dollar of the revenue, the company retains $0.25 for the rest of its expenses.
Fixed versus Variable Costs
A fixed cost, as the term implies, does not change whether there is an increase or decrease in the volume of goods or services produced. They are easy to predict and to plan for, like rent, utilities, and salaries. Variable costs are the opposite. They depend on the production of the business, and thus, can be harder to predict.
Equity versus Debt
Equity refers to money from investors in exchange for some ownership of the company. Debt, on the other hand, includes loans from a bank and needs to be repaid. Businesses that are looking to expand and grow will need both, and knowing the difference is vital in determining your company’s future.
Leverage is more commonly known as the debt taken on to finance the business. As mentioned above, the balance between debt and equity is very important. If you have more debt compared to equity, you are labeled as highly leveraged and risky to potential investors.
Capital Expenditures (CapEx) and Operating Expenses
Some items are investments for the business because they will be used beyond the taxable year. They may be computers or equipment vital to production. On the other hand, operating expenses may be deducted fully in the same tax year. Examples include office supplies and insurance costs.
The road to success involves smart financial decisions. Though you may have a financial team backing you up or even a mentor guiding you, it is necessary for every entrepreneur to have at least a basic understanding of financial terms and concepts. Making the right steps and choices depend on this as well.