Business Finance Basics For Entrepreneurs5 min read

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Executive Summary

Building a company from scratch is no easy feat. Kudos to you if you have managed to successfully do so or are trying to!  That being said, business success has a lot to do with financial literacy, too. Not knowing fundamental financial concepts can potentially stall or stop your company from growing and prospering. Here are some key financial terms that you as an entrepreneur have to know when managing and running your business.  

Accounts Payable

Accounts payable (AP)  refers to any money a business owes to its suppliers in the form of legitimate bills and invoices. The total money owed is represented as a liability on the business’s balance sheet. A proper invoice should include a unique invoice number, a proper description of goods and services provided, and the amount due.  

Accounts Receivable

Accounts receivable (AR) represents the amount of money owed to a particular business for goods and services rendered to its customers. In simple terms, instead of money owed, it is money to be received. Accounts receivables are indicated on the balance sheet of a business as current assets that have yet to be paid for by the customers 

Assets 

An asset is something that has value, whether tangible or intangible, and is owned by the business. Think of an asset as a useful item that could possibly decrease the expenses of a business, or even ensure cash flow to pay its outstanding debts. Examples of assets include machinery, equipment, and even cash. 

Balance Sheet

A balance sheet provides a ‘bird’s eye view’ of the business’  net worth (value) at any given time frame. From a balance sheet, one can tell what a company owes (liabilities), what it owns (assets) as well as whether it has been invested in by shareholders. The aim of a balance sheet is to provide the necessary information regarding the financial situation of a business. 

Cash Flow

Cash flow can be regarded as the total amount of money being transferred into and out of a business. Cash flow can be positive or negative. Positive cash flow indicates that a company is augmenting its cash reserves to pay debts, pay out money to shareholders, or even invest in itself. A negative cash flow, on the contrary, happens when a business spends more money than it makes during a particular time frame.  Generally, cash flow comes in three forms, investing, financing and operating. Investing cash flow covers a business’ investments in ventures as well as its purchases of capital assets. Financing cash flow covers all gains that have been collected by a business from paying its debts, issuing equity to shareholders, and issuing debt. Operating cash flow can be defined as all the cash that is produced due to the primary activities of a business. 

Income Statement 

The income statement also referred to as its profit and loss statement. This statement is an overview of the expenses and revenues of a business over a given time Potential investors usually refer to the net figures in the income statement to assess the long-term growth prospects and even profitability of a business. Note that the income statement does not measure the cash flow of a business. 

Liability 

The liability of a business represents its legal obligation to settle or repay outstanding debt. Liabilities can be classified as either current (payable within one year or less) or long-term (payable after one year) and are listed on a business’s balance sheet. They can be paid in the form of goods, services, or money. Examples of liabilities that a business can incur include but are not limited to accounts payable, loans, and mortgages.

Annual Percentage Rate

The annual percentage rate (APR) refers to its annual rate of interest and fees charged to borrowers and paid to lenders The APR of a business is generally represented as an interest rate and calculates the percentage of the principal the business would pay annually, after considering factors such as monthly payments. APR does not include compounding interest within a particular year when paying out the annual rate of interest to investors. 

Debt-Service Coverage Ratio

The debt-service coverage ratio (DSCR) refers to the cash a small business has available for paying its debt. DSCR reflects the capability of a business to use its earnings (before interest and taxes) to pay back all its short and long-term debts (both principal and interest). DSCR  is calculated based on the formula 

 DSCR = Net Operating Income/Total Debt Service

Lien

The lien of a business is its creditor’s legal claim to the collateral pledged by the business as security for a loan. If the business fails to fulfill its underlying obligation, such as the repayment of a loan to its creditor, the creditor has the legal basis to take over the asset marked as collateral by the business to satisfy the debt. If you have a corporate lien, you might have a debt owed to the government or to another business. The safest bet is to avoid defaulting on your payments

Gross Profit

You as a business owner would like to generate a gross profit as a result of running your company. Gross profit can be defined as the profit a business generates after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross profit can be derived by deducting the cost of goods sold from the revenue or sales of a business. This figure will appear on the income statement of a business. 

Concluding Thoughts

Being an entrepreneur often means you will be wearing several hats, including that of a financial controller and accountant. Kickstart your financial literacy journey early to ensure your business’s financial health remains in good stead. Brace yourself to face upcoming business and financial challenges with an increased understanding of important concepts in business finance. 

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