Introduction
The world of finance has its own language, and it can be intimidating. As you settle your accounts, you might come across a word you don’t know or don’t quite understand. How do you know if it’s something important or another word for a simple concept?
You don’t have to be a financial expert to run a business, but it is helpful to know some key terms. Understanding both common and confusing terms makes it easier to reconcile your books and ensure your business is financially sound. In this article, we’ll go over key financial terms to know, plus some confusing terms you’re likely to encounter.
Terms to Know
These are some financial terms every business owner needs to know to run a profitable organization.
Accounts Payable:
Definition: bills or amounts due that are paid by the business to another entity
Why it’s important: Your accounts payable records help you calculate costs and liabilities, as well as avoid default. It’s a way to keep track of both regular and unique expenses in your business so you can plan cash flow accordingly.
Accounts Receivable
Definition: these are outstanding invoices to be paid to the business
Why it’s important: Managing your accounts receivable invoices and cash flow ensures timely collection of revenue and helps you resolve all outstanding invoices. It’s an important accounting practice because without money coming into your business, you’ll run out of cash for daily operations.
Balance Sheet
Definition: a financial statement that shows the balance of your assets and liabilities at a given point in time
Why it’s important: Balance sheets are helpful tools when you need to take a pulse check of your business and ensure you’re moving toward your financial goals. They show if you’re hitting benchmarks and progress toward business milestones.
Cash Flow
Definition: all of the money coming in and going out of your business
Why it’s important: Cash is the fuel in your business. Managing cash flow means making sure there’s always money in your business’s bank account to support overhead and the costs of operation. It’s often helpful to set a minimum balance that you’ll keep in your account at all times to ensure there’s always cash if you need it.
Fixed Expenses
Definition: expenses or costs that remain the same as your business grows, such as rent, subscriptions, equipment leases, etc.
Why it’s important: It’s important to understand expenses in relation to your revenue. As your business grows, your fixed expenses will become a smaller percentage of your total revenue. This is because they remain the same as your revenue increases. The lower you can keep your fixed expenses, the greater profit you can take from your total revenue.
Gross Profit
Definition: profits before taxes, fees, and payroll
Why it’s important: Your gross profit shows how much revenue your business is making. It reflects the total amount of money coming into your business, without factoring what’s going out. It’s a good indicator of business performance and profitability.
Net Profit
Definition: profits after taxes, fees, and payroll
Why it’s important: Your net profit reflects the money left over after expenditures and overhead costs. This is your income — the money you take home after the bills are paid. It’s important to ensure your service pricing supports your net profit, not just the gross profit. If you don’t figure operating expenses into your profit calculations, then you might end up with high gross profit margins but very little income.
Overhead
Definition: costs such as rent, utilities, administrative expenses; the costs of doing business
Why it’s important: These costs are the difference between your revenue and your income. It’s important to keep them as low as possible so you can increase your net profits. Consider how much cash it takes to fund your overhead each month and factor that into your monthly budgeting and revenue goals.
Variable Expenses
Definition: expenses or costs that change and fluctuate in relation to your business activity, such as making a sale
Why it’s important: Your percentage of variable expenses will continually change as you earn more revenue. Many of these expenses are based on the total amount collected, which is why they aren’t consistent like fixed expenses. It’s important to plan for the cash flow you’ll need to cover these variable expenses to ensure you reach your desired profit margins.
Working Capital
Definition: how much money you need to operate your business day to day
Why it’s important: Working capital tells you how much money you need to keep in your bank account at all times. It will serve as the foundation for your cash flow management, so it’s important to be as accurate as possible. Think of everything your business has to pay each month and add in some padding for one-time bills or fees.
Confusing Terms
These are financial terms you’ve probably heard before but aren’t quite sure what they mean or how they affect your business.
Assets
Definition: these are items, investments or ownerships that are worth money when liquidated and are factored into the overall value of your business
Why it’s important: Assets help to determine your business’s value to lenders, investors, and partners. They’re often included as collateral in business loans and may be used to determine how much insurance you need. The main types of assets found in naturopathic clinics include the building itself (if you own it), office equipment and medical equipment.
Budget Allocation
Definition: assigning portions of your revenue to different costs such as overhead, payroll, and profits
Why it’s important: Budget allocation is a key aspect of the Profit First approach. In this method, you allocate money toward your profits before setting any aside for other expenses. This helps you set up and manage your business finances in a way that supports the profits you need to make to succeed.
Cash Only
Definition: a practice in which a medical business accepts only cash payments instead of billing through insurance companies
Why it’s important: A cash-only practice makes billing and collecting payments much easier for a naturopathic practice. It eliminates the hassle of having to work with insurance companies and gives you the opportunity to provide better care for your patients.
EBITDA
Definition: stands for “earnings before interest, tax, depreciation, and amortization”
Why it’s important: You’ll likely only encounter this term if you’re looking for investors in your business. Your business’s EBITDA is an important indicator of success and cash flow (before expenses) that helps investors or partners decide if your practice is a sound investment.
Income Statement
Definition: similar to a balance sheet, your income statement shows all of the revenue and expenses in your business
Why it’s important: You have to subtract expenses from revenue to find your monthly income. An income statement shows you exactly where you’re receiving and spending money, which is helpful if you need to rebalance your budget allocation to preserve profits.
Liabilities
Definition: financial debts your business owes to other entities
Why it’s important: This term often makes naturopathic doctors think of their office and malpractice insurance, but it means something different in the financial world. When it comes to your accounts, liabilities are loans or lines of credit that you could potentially default on. It’s important to keep these liabilities to a minimum and factor regular payments into your overhead expenses.
Profit Margin
Definition: the percentage difference between your net profits and total expenses
Why it’s important: Your profit margin reflects how much income your business earns in a given period of time. The key is to ensure that your profit margin supports the level of income you need to live comfortably while running your business. The Profit First approach makes this your first priority to help ensure financial stability and professional success.
Approach Finances with Confidence
Now you’re equipped with some professional financial knowledge! You can take on your business accounts with confidence because you understand the language. As you dig through your income statement and balance sheets, you’ll be able to make informed decisions that support your business goals.
To build on your knowledge from this post, you can take the next step in understanding business finances: Read our blog about Financial Skills Every Business Owner Should Have.