Key Financial Reports and Terms Every Small Business Owner Should Know
Learn the key financial terms and reports all small business owners should know to master financial management.
Have you ever sat down for a well-deserved cup of coffee, opened an email from your accountant, and read through a maze of financial reports that are so complicated you might as well be reading Greek? Many small business owners need clarity regarding financial terms, often leading to missed opportunities and expensive mistakes, especially during tax season. According to a recent survey, 42% of small business owners needed more financial literacy before starting their businesses.
Financial literacy starts with having a basic understanding of important financial terms, including those used in various financial reports. Navigating small business finance without this knowledge is like trying to fix leaks without knowing which tools to use. On the other hand, understanding these concepts allows you to make better decisions, negotiate better deals, and identify potential issues early.
This article will explain the essential financial terms that every small business owner should know. By the end, you will be familiar with financial statements and reports, giving you the information you need to steer your business toward success.
Key Terms for Financial Reporting, Analysis, and Management
Financial Analysis
Understanding how to measure revenue, expenses, and profitability will give you an idea of how well you manage your business operations, including your readiness for expansion or additional investments.
- Gross Income/Profit: The total earnings from all revenue sources after subtracting the cost of goods sold (COGS), such as materials and labor. This shows how much your business makes before other expenses are taken out.
- Gross Profit Margin: The percentage of sales revenue that remains after deducting COGS. It indicates how efficiently your business produces and sells its products or services.
- Net Income/Profit: The profit your business earns after all expenses, taxes, and costs are subtracted from total revenue. This is the bottom line and represents the actual take-home earnings of your business.
- Net Profit Margin: The percentage of revenue remaining after deducting all expenses, taxes, and costs. It shows how much profit your business makes for each dollar of revenue.
- Break-Even Analysis: A calculation to determine when your business's total revenue will cover all its expenses, indicating the point at which it starts making a profit.
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): A measure of your business's overall financial performance, focusing on profitability from core operations, excluding the effects of financing, accounting decisions, and taxes.
- Liquidity: The ability of your business to quickly convert assets into cash to cover liabilities and unexpected expenses, ensuring smooth operations.
- Accounts Payable (AP): The amounts your business owes to suppliers and vendors for materials, equipment, and other goods or services purchased on credit.
- Accounts Receivable (AR): The money owed to your business by customers for services or products provided, typically represented by outstanding invoices.
- Return on Investment (ROI): A measure of the profitability of an investment, calculated by dividing the net profit by the cost of the investment, showing how well an investment is performing.
Financial Reporting
Part of preparing for growth is being able to generate accurate reports that can attract potential investors and fulfill regulatory requirements.
- Income Statement (Profit and Loss Statement): A summary of your business's revenues, costs, and expenses over a specific period, showing whether your company made a profit or loss during that time.
- Balance Sheet: A snapshot of your business's financial condition at a specific point in time, detailing assets, liabilities, and owner's equity. It helps you understand what your business owns and owes.
- Cash Flow Statement: A report that details the cash coming into and going out of your business during an accounting period. It helps assess your business's liquidity and overall financial health.
- Statement of Shareholders’ Equity: A report that shows changes in your business's equity over a specific period, including contributions, distributions, and retained earnings.
- Annual Report: A comprehensive report summarizing your business's financial performance over the past year. It includes income and cash flow statements and a balance sheet, providing an overall picture of your business's health.
Financing and Capital Management
Debts and capital are important components of financing a business, and knowing how credit works can help you choose the right financing strategy.
- Working Capital: The difference between your current assets and liabilities, indicating how much money you have available to cover short-term expenses and daily operations.
- Debt Financing: Borrowing money that must be repaid with interest, such as taking out a loan to buy new equipment for your business.
- Equity Financing: Raising money by selling your business shares to investors and providing them partial ownership in exchange for capital.
- Interest Rate: The cost of borrowing money, expressed as a percentage of the loan amount. It determines how much extra you will pay in addition to repaying the borrowed sum.
- Amortization: The process of spreading out loan payments over a set period, usually through regular installments that cover both principal and interest.
- Line of Credit: A flexible loan from a bank that provides access to a set amount of money, which you can draw from as needed and repay over time.
- Leverage: Using borrowed money to increase potential returns on investment, such as taking a loan to expand your business operations.
- Collateral: An asset, like an office building, offered to a lender to secure a loan. The lender can seize the collateral if you fail to repay the loan.
- Business Credit Score: A measure of your business's creditworthiness based on financial information like payment history, helping lenders and suppliers determine the reliability of your business in repaying loans.
- Factoring: Selling your accounts receivable to a third party at a discount to get immediate cash, providing upfront payment for your invoices rather than waiting for clients to pay.
Risk Management
All businesses face different risks, and you must understand them to prepare for or avoid potential disruptions.
- Insurance Premiums: The regular payments you make to maintain your insurance coverage, ensuring protection against various risks.
- Credit Risk: The risk that your business will not be able to pay its debts to suppliers, which could affect your creditworthiness and business relationships.
- Operational Risk: The risk arising from the daily operations of your business, including potential employee injuries, equipment breakdowns, and other operational disruptions.
Investment
Investing can be costly, but it’s also crucial if you want more efficient operations, including automating your processes and upgrading your equipment/facilities.
- Capital Expenditures (CapEx): The funds your business uses to purchase, maintain, or improve fixed assets like vehicles, equipment, or property. These investments are intended to benefit your business over the long term.
- Depreciation: The reduction in the value of your assets over time due to wear and tear, such as older vehicles or equipment that require more maintenance and repairs as they age.
Financial Ratios
Financial ratios are a good indicator of a business’s liquidity or cash management, including its ability to pay for unexpected expenses.
- Current Ratio: Measures your business’s ability to pay short-term obligations using its current assets. It helps determine if you have enough resources to cover immediate liabilities.
- Quick Ratio: Assesses your business’s ability to pay liabilities without selling inventory or taking a loan. It provides a more stringent test of liquidity by excluding inventory from assets.
- Debt-to-Equity Ratio: This ratio compares your total debt to your total equity, indicating how much of your business is financed by debt versus owned capital. A higher ratio suggests more reliance on borrowed funds.
- Gross Margin/Profit Ratio: The percentage of revenue remaining after deducting the cost of goods sold (COGS). It shows how effectively you control production costs and manage pricing.
Compliance and Governance
All businesses need to comply with government regulations or industry standards to keep operating and maintain customer trust.
- Audit: An official review of your business's financial records to verify their accuracy, completeness, and compliance with regulatory standards.
- Compliance: Adhering to laws, regulations, and standards relevant to your business operations and industry, ensuring legal and ethical conduct.
- Internal Controls: Processes and procedures implemented within your business to safeguard assets, prevent fraud, ensure accuracy in financial reporting, and comply with regulations. These controls help minimize risks and promote operational efficiency.
Adopt Financial Terms Seamlessly Through Decimal
Understanding financial terms is crucial for making informed decisions that keep you in business and prepare you for future growth. At Decimal, we simplify this process by automating your financial operations, ensuring you have accurate, up-to-date financial reports at your fingertips. Our solutions take the guesswork out of bookkeeping and accounting, so you’re always on top of your financial health and have the confidence to implement the best strategies for your business.
Schedule a free consultation with our bookkeeping experts to turn all the financial jargon into actionable growth.
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