Don’t leave all the financial knowledge to your accountant, as a business owner you should know these basic accounting terms.
When you’ve got a small business to run, learning basic accounting terms doesn’t land high on the ‘to do’ list. But if you want to turn that business into a thriving one, you have to at least learn the basics.
These accounting terms define the business accounting basics and can give you the insights you need to keep your operations running smoothly.
Cash flow is a snapshot of the timing and amount of cash coming into and out of the business at any given time. It’s a calculation of all cash collected and spent on operations, investments and financing. It is important to be aware of cash flow to time purchases.
You should review your cashflow monthly and annual cash-flow statements to identify trends, set goals and predict coming ebbs and flows. Remember, no matter how profitable you are, if you don’t have the cash to cover your expenses you will run into trouble. The biggest reason companies go out of business is because they run out of cash.
Comparing past cash-flow statements with projected income and expenses allows you to estimate the amount of money that will move through your business in a future period of time. You can use that forecast to build scenarios based on new projects or investments, or to determine when to invest in the business, pay off debts or to pay yourself. We suggest doing cash-flow forecasts at least once a year, and more often if cash flow is tight.
Marginal cost is the difference in profit you make by selling one more unit. You can find it by dividing the total cost of production by the number of products you want to make and comparing the results. Knowing your marginal costs will help you figure out whether making more items will be profitable. Keep in mind that while increasing production may lower the per item cost, it may also require hiring new staff, expanding operations or investing in new equipment, which can alter the outcome.
An income sheet details the net profit a company makes in a period of time, based on all revenues minus all expenses. It is a useful benchmark for performance and understanding profit.
A financial statement is a collection of all the reports documenting every financial transaction a company has made. It includes the balance sheet, profit and loss (P&L) or income statement, and cash-flow statements. A financial statement is a valuable tool for understanding exactly how your business is doing.
Gross & Net Profit
Gross profit is the profit you make after subtracting the direct cost of producing your product. For example, if you make a portion of cod and chips for £2 and sell them for £6, your gross profit is £4.
Net profit is the amount of income a company has left after all other expenses are paid, including wages, rent, debt payments, phone bills and other operating costs. A lot of people mistake gross profit for net profit so understanding the difference will help you price your products appropriately, and ensure your business is truly profitable.
These basic accounting terms aren’t just financial jargon that should be left to your accountant. They are financial tools that can help you predict profit, make better financial choices and avoid the pitfalls that destroy new companies.