Ask someone to define finance and many struggle and find it hard to put in to words. Finance according to Wikipedia is a term for matters regarding the management, creation, and study of money and investments. As such finance affects all our lives. There are some essential finance terms entrepreneurs need to know.
Surely profit is the goal of all entrepreneurs. At first glance many think that profit is the money made from the sale of a product or service. As an entrepreneur you realize that it is what is left when all the expenses have been deducted. Before the expenses are deducted what we are actually talking about is income.
When you sell products or services you generate income, sometimes known as revenue. You may generate a lot of income but if your overheads, staff costs and expenses are high you may not actually generate profit. It is very common for a new business to run at a loss at first. This is why many entrepreneurs decide the best way to make money from home is in affiliate marketing as it keeps your expenses low.
Gross vs Net income
Another way you may hear business finances referred to is gross income and net income. Net income is the difference between your gross income and your expenses. The gross income is the total income of your business before any expenses are subtracted. Net income is the difference between the gross income and the expenses.
Return on investment or ROI as it is commonly called is a way to monitor your costs. All businesses will need some investment in money as well as time. The money invested will include regular capital expenses and operating expenses. Some of the operating expenses will include advertising and marketing costs.
When weighing up advertising mediums it is important to monitor your ROI. If you spend $20 a day on ads but they bring an additional $100 of business then your ROI is x5 and clearly worth continuing with.
You can see that monitoring your costs is a vital part of running a successful business. What isn’t measured can’t be managed is a quote usually attributed to Peter Drucker. Basically it means you have to know the current state of your finances in order to improve on them.
Your balance sheet should list all the assets and liabilities of your business. You need to monitor your expenses and expected income that hasn’t yet been received. Many businesses expect to have 30 days to pay invoices. If you are running to very tight margins this can impact on your cashflow.
When you sell products or services there may be a delay before you receive payment. If you have to lay out for materials or services before you make the sale this can be a problem. Cashflow refers to the relationship between money in and money out.
You need to ensure that your cash flow is under control. Basically this means that you need to make sure you can continue running your business until those outstanding funds are received. This can become even more important if you are subjected to a bad debt. If a customer doesn’t pay when they should it could be some considerable time, if at all, before you receive your money.
Having a positive cashflow is what every entrepreneur wants. This means you have more money coming in than going out. Advantages this gives are that you can ride out late payments and sudden changes in income.
Nobody could have predicted the pandemic in 2020 and the businesses that survive will be those that had built in safety margins.
As a new entrepreneur you will naturally concentrate on day to day finances. But there is a long term value to any business. The residual value is the return on investment over the life of your business. This can be tricky to quantify but will depend on the average rate of return, the age of the business and the rate of growth. It will also take in to account assets that the business has acquired. This could be in the form of equipment, property or digital assets like customer lists.
We have looked at many of the essential terms you should know as an entrepreneur in business. The sum result of all these things will reflect in the overall financial position of your business. When credits, liabilities, assets and cashflow are taken in to consideration you will have a good idea of your overall financial position.
As with all areas of life you should set goals for your business. Financial goals will help you grow in a sustainable way. These goals need to meet the SMART guidelines. That is they need to be specific, measurable, attainable, relevant and timed.
It is good to set goals for 1 year, 5 years and 10 years. You may have heard the statement“People tend to overestimate what can be done in one year and to underestimate what can be done in five or ten years.”Click To Tweet
The saying has been attributed to many people over the years. Many say Bill Gates but in fact it was probably the computer scientist J. C. R. Licklider.
Whoever first said it, many budding entrepreneurs have found it to be true. So make your goals realistic and celebrate your wins along your journey.
Take this survey operated by a company that have made over $100million in sales over a period of 20 years. It identifies areas in your own specific business where you can improve.
Finance is a broad topic and can be confusing. Above are the main essential finance terms entrepreneurs need to understand to establish a successful business. You can study how to implement these in books or finance courses. But is that the best use of your time? I definitely think you need to know and understand the financial areas that impact your business.
However you may want to outsource a lot of the details to a finance professional. As soon as your financial position allows you should consider outsourcing this area of your business. It can be false economy to try to do everything yourself. Bookkeepers, accountants and tax advisers could actually be the essential finance terms entrepreneurs need to know!