What are some common accounting terms that business owners should know?

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    Stephen Woicik

    If you are starting or already running your business you may not be an account or finance expert. But as the owner of the business you are expected/required to have a basic knowledge of this very important part of your company. Even if you outsource your accounting to a third party, you need to be able to understand and make decisions based on the data. Having a better understanding of your company's financial situation, will make you a better decision maker.

    Some terms that I have learned and found essential to running my business. Please keep in mind that I am not an accountant. This advice is coming from someone who has run a business for the past 9 years and has had to learn as I go.

    Accounts Payable – Any money that is owed to a creditor. This will be any invoice or expense that your company receives that has not been paid yet.

    Accounts Receivable – Any money that is owed to your company. Outstanding invoices or other forms of income that will be received by your business.

    Assets – What your company has. This usually includes cash, inventory, account receivable, equipment, and any property you may own.

    Balance Sheet – A standard financial statement that includes assets (what you own), liabilities (what you owe), and owners equity. Assets = Liabilities + Owners Equity.

    Cost of Goods Sold – This will account for all the direct expense that are involved in producing your product. For example, if you produce scarfs, then yarn will be part of cost of goods sold.

    Fixed Expense – This is an expense that will not change based on the size or amount of sales your company has. For example, the rent in my office is $600. If I sell 1 product or 100 products my rent stays the same.

    Variable Expense – This is an expense that will change based on the size or amount of sales your company has. For example, shipping expenses will changes based on the amount of sales you have since you have to pay per item shipped.

    Gross Profit Margin – is a calculation that helps determine how much profit you are making on each thing that you sell. This calculation only takes into account things directly related to your product. It does not account for expenses outside of your product or service. The calculation is Gross Profit Margin = (Revenue – Cost of Goods Sold)/Revenue. This formula will product a percentage that is your gross profit margin.

    Net Income – Your company's total earning. This is calculated my subtracting all your revenue from all your expenses.

    Gross Profit – This is determined by taking your company's total revenue and subtracting the cost of goods sold. This will determine the amount of money your product or service is generating. It does not take into account operating expenses, interest, or other liabilities or capital your company has as a whole.

    Operating Expense – These are expenses related to the running a business. Expenses that are required for you to keep the doors open, but not necessarily related to your product. You can think of these as administrative or general expenses. For example, buy office supplies is needed to run a business, but not directly related to the product you sell.

    Return on Investment – This is a calculation to determine your company's financial performance based on the amount of capital invested. This is usually calculated by taking the net profit divided by the cost of investment. Typically this is expressed as a percentage.

    Cash Flow – The Cash Flow Statement is a common financial statement that will help determine how much money is coming into and leaving your company. A positive cash flow means your a making more money then you are spending, a negative cash flow means you are losing money.

    I would also add that as a business owner, when you are evaluating the financial state of your business that you learn to deal in percentages. It's easy to lose track when you are dealing with raw numbers. We arbitrarily attach a personal value to dollar amounts by percentages are harder to explain away. For example if something on you operating expenses is only $100 dollars it may seem in-material, but if that makes up 10% of operating expenses it's harder to ignore.

    Feel free to add your own. Did you have a solid financial understanding when you started your business?

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