WHAT YOU NEED TO KNOW TO START A BUSINESS

Welfont Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.

You may have some great ideas and believe that you’re ready to make one of them a reality – but starting a business isn’t just about amazing ideas; there’s a great deal of practical knowledge that must be effectively applied in order to facilitate (not guarantee!) success. Before committing to a project, be certain that you fully understand your idea’s financial aspects and the likelihood of its being truly viable.

In this article, I’ll be covering a few financial basics that you’ll need to understand in order to help ensure that you have the requisite financial knowledge to start a business. Please take note that this list isn’t by any means meant to be comprehensive. For a better understanding of your particular business’ finances, make an appointment to consult with an accountant.

When vetting a specific business idea, creating a business model canvas can help you to determine the resources necessary to get up and running, how much it’s likely to cost, whether there’s a market for the concept, and whether it could potentially be profitable. Part of this process will include rendering your idea into financial terms.

FINANCIAL TERMS

The following terms are shown in alphabetical order:

Accounts Payable

Accounts payable is the total amount that your business owes to others. This figure can represent inventory, utilities, rent, services, and more.

Accounts Receivable

Accounts receivable (AR) is the total amount that is owed to your business in exchange for your products or services. This figure represents the sum of your open invoices.

Assets

Assets are anything owned by your business having intrinsic cash value. This includes inventory, accounts receivable, any owned property or equipment, cash, and more. Assets constitute an important part of your business’ overall health.

Break-even Analysis

A break-even analysis will help you to determine exactly when your revenues will exceed your expenses.

Burn Rate

It’s essential to know how much money it costs to operate your business, especially if you aren’t yet profitable. Most businesses will experience a period of time early in their lifecycle when they aren’t making money. Knowing your burn rate – or how much money is necessary to operate your business each month – provides direct information on how much money is required to continue.

Cash Flow

Knowledge of how money moves through your business – cash flow – matters. Evaluating how much cash you have on hand at both the beginning and end of a given month can help you to determine your cash flow and thereby provide insight into your business’ degree of solvency. Knowing that you can meet all of your financial obligations is of critical importance when attempting to run a successful endeavor. Cash inflows are your revenues, while cash outflows are your expenses.

Costs of Goods Sold (COGS)

If you’re selling a product, then you’re either paying to have it made or paying for a finished product that can be resold. The amount that you pay for those products is your costs of goods sold. Services can also have an associated COGS, as COGS includes labor costs in addition to raw materials. These costs are sometimes referred to as ‘direct costs.’

Depreciation

The equipment and property that your company owns lose value over time. This loss is called ‘depreciation.’ The act of depreciating your equipment and property enables you to claim a tax deduction for this loss of value.

Equity

Equity can mean one of two things. For small business owners, equity is generally the personal assets (usually cash) that they have invested into the business. For those companies which have accepted stock in trade for investment, equity is their ownership interest in the business.

Expenses

Expenses are, essentially, your cost of doing business. Your business will likely have fixed expenses such as rent and loan payments. Regardless of how much your company is earning, you can generally count on these expenses to remain static over time. Variable expenses – those that change month-to-month depending on sales volume or other factors – include shipping costs, cost of goods sold, payroll, and more.

Gross Margin

Gross margin is a percentage that denotes how much money you’re earning per dollar of revenue. If you have a 15% gross margin, you’re earning $0.15 on every dollar of sales. To determine this number, subtract your COGS from your revenue and then divide the result by the revenue. Having an understanding of your gross margin is important, as it can help you to decide whether you should reduce your COGS or increase your prices.

Gross Income

Gross income is all of the money earned prior to expenses.

Liabilities

Anything you owe is considered to be a liability, including business loans or other debts, accounts payable, and payroll.

Net Income

Net income is your profit – it’s gross income minus expenses. When trying to determine viability, net income is a better indicator than gross income.

Profit Margin

Profit margin informs you of how much you’re retaining from each dollar of sales after accounting for all expenses. To calculate it, divide net income (gross income minus expenses) by total sales. A 20% profit margin shows that your company is earning $0.20 for each dollar of sales. Increasing the profit margin will require either increasing the cost of your product/service or decreasing expenses.

ROI

Return on investment (ROI) is the percent of profit you’re earning on the money you’ve invested into business operations. To determine your ROI, divide net profits by your investment.

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