This is a rewrite of an older post, but it seems like a good one to repeat. You don’t have to be an accountant or an MBA to do a business plan, but you will be better off with a basic understanding of these six essential financial terms. Otherwise, you’re doomed to either having somebody else develop and explain your numbers, or not having your numbers correct.
It isn’t that hard, and it’s worth knowing. If you are going to plan your business, you will want to plan your numbers. So there are these six terms to learn. I’m not going to get into formal business or legal definitions, and I will use examples:
- Assets: cash, accounts receivable, inventory, land, buildings, vehicles, furniture, and other things the company owns are assets. Assets can usually be sold to somebody else. One definition is anything with monetary value that a business owns.
- Liabilities: debts, notes payable, accounts payable, amounts of money owed to be paid back.
- Capital (also called equity): ownership, stock, investment, retained earnings. Actually there’s an iron-clad and never-broken rule of accounting: Assets = Liabilities + Capital. That means you can subtract liabilities from assets to calculate capital.
- Sales: exchanging goods or services for money. Most people understand sales already, but the timing of sales is important. Technically, the sale happens when the goods or services are delivered, whether or not there is immediate payment, and regardless of how long ago you paid for what you’re selling.
- Cost of Sales (also called Cost of Goods Sold (COGS), Direct Costs, and Unit Costs): the raw materials and assembly costs, the cost of finished goods that are then resold, the direct cost of delivering the service. This is what the bookstore paid for the book you buy, it’s the gasoline and maintenance costs of a taxi ride, it’s the cost of printing and binding and royalties when a publisher sells a book to a store for resale. And timing is important for this one too: it gets into the books at the same time that the sale is made, regardless of when you bought it or paid for it.
- Expenses (usually called operating expenses): office rent, administrative and marketing and development payroll, telephone bills, Internet access, all those things a business pays for but doesn’t resell. Tax and interest are also expenses. And the timing is supposed to be when you are committed to the expense, regardless of when you pay for it.
- Profits (also called Income): Sales less cost of sales less expenses. Expenses in this case includes depreciation, amortization, interest, and taxes. And if you don’t know what depreciation or amortization are, don’t sweat it, neither one of them belongs in my list of six essential terms.
Sure, you can spend a lifetime analyzing and getting to know the ins and outs of it, but these are basics every business owner and entrepreneur should know. In my opinion.