Here are 7 financial concepts to better understand your small business and to help secure a loan
Most start up entrepreneurs have great talent and passion – but often lack an understanding of basic financial concepts. Especially when approaching lenders, understanding these financial concepts can be vital to securing the capital you need to help your business succeed. Sometimes, entrepreneurs may even understand the concept but not use the more commonly used terms so that their audience is left skeptical about their understanding of basic cost structures and financial principles and how they affect the business’ bottom line (the first financial term we are going to define!).
To help you get started on the right financial footing and ensure confidence from your team, your financiers, your investors and your bankers – here are seven basic finance terms that every entrepreneur should understand and know.
1. Bottom Line
Net earnings and net income are other terms used to describe the “bottom line”. You may hear people talk about “affecting the bottom line” of the company and this is simply any action that may increase or decrease the company’s net earnings, or overall profit. The term “bottom” is in reference to the typical location of the number on a company’s income statement, below both revenues (top line) and expenses. Needless to say, this is an important term to know and one that gets used all the time.
2. Gross Margin
Gross margin is expressed as a percentage and represents the percent of total sales revenue that a company keeps after subtracting the cost of producing its goods or services. The higher the percentage, the more the company keeps on each dollar of sales. In simple terms, if a company’s gross margins are 40%, for every dollar of revenue that is generated, the company will retain $0.40 before paying its overhead, which includes salaries, rent, and more.
3. Fixed versus Variable Costs
A fixed cost is exactly what it sounds like, a cost that does not change with increases or decreases in the volume of goods or services that are produced by your company. These costs are obviously the easiest to predict and plan for. Rent and salaries all usually fall into this category and will “be there” whether you have business or not!
Variable costs are just the opposite. They can vary depending on what your company is producing and how much of it and as a result are much harder to forecast.
4. Equity versus Debt
The “equity versus debt” comparison may seem silly to some, but you would be surprised at how many people we come across who have no idea what either really means. Equity is simply money obtained from investors in exchange for a % ownership in your company, while debt comes in the form of loans that must be repaid over time. Both are necessary for growth, with their own pros and cons. Equity versus debt is a critical decision for any entrepreneur and it is important to know the difference.