Business Finance Terms for Small Business Owners: A Comprehensive Guide, Exercises of Finance

Download Business Finance Terms for Small Business Owners: A Comprehensive Guide and more Exercises Finance in PDF only on Docsity! BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 1 Business and Finance Terms to Know Running a business involves a constant learning curve. And that applies whether you’re a rookie entrepreneur just starting out with a great idea for a new business or a more established small business owner with a quickly growing business that needs to expand. You should always be learning as a business owner, no matter where you are in your career—there’s always a new tool to master, new problems to solve, and new vocabulary to understand. In order to not get totally overwhelmed, it’s helpful to take things one segment at a time. For instance, feeling confident when discussing the business’s financial needs should be a priority for every small business owner. After all, you represent the heart and soul of your business in the marketplace. So knowing the “language” of business finance is an integral part of your job as the owner. The good news is that you don’t have to be an accountant or a financial planner to negotiate in the world of business finance. Here are some business terms and finance terms that will help you find your way to successful small business funding. From accounting, to business loans, to general business financial operations, this booklet contains the ultimate list to all the business finance terms and definitions you need to know! BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 2 1. Accounts Payable Accounts payable is a business finance 101 term. This represents your small business’s obligations to pay debts owed to lenders, suppliers, and creditors. Sometimes referred to as A/P or AP for short, accounts payable can be short or long term depending upon the type of credit provided to the business by the lender. 2. Accounts Receivable Also known as A/R (or AR, good guess), accounts receivables is another business finance 101 term that means the money owed to your small business by others for goods or services rendered. These accounts are labeled as assets because they represent a legal obligation for the customer to pay you cash for their short-term debt. 3. Accrual Basis The accrual basis of accounting is an accounting method of recording income when it’s actually earned and expenses when they actually occur. Accrual basis accounting is the most common approach used by larger businesses to record and maintain financial transactions. 4. Accruals A business finance term and definition referring to expenses that have been incurred but haven’t yet been recorded in the business books. Wages and payroll taxes are common examples. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 5 13. Fixed Asset A tangible, long-term asset used for the business and not expected to be sold or otherwise converted into cash during the current or upcoming fiscal year is called a fixed asset. Fixed assets are items like furniture, computer equipment, equipment, and real estate. 14. Gross Profit This business finance term and definition can be calculated as total sales (income) less the costs (expenses) directly related to those sales. Raw materials, manufacturing expenses, labor costs, marketing, and transportation of goods are all included in expenses. 15. Income Statement Here is one of the four most important reports lenders and investors want to see when evaluating the viability of your small business. It is also called a profit and loss statement, and it addresses the business’s bottom line, reporting how much the business has earned and spent over a given period of time. The result will be either a net gain or a net loss. 16. Intangible Asset A business asset that is non-physical is considered intangible. These assets can be items like patents, goodwill, and intellectual property. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 6 17. Liability This business finance key term is a legal obligation to repay or otherwise settle a debt. Liabilities are considered either current (payable within one year or less) or long-term (payable after one year) and are listed on a business’s balance sheet. A business’s accounts payable, wages, taxes, and accrued expenses are all considered liabilities. 18. Liquidity Liquidity is an indicator of how quickly an asset can be turned into cash for full market value. The more liquid your assets, the more financial flexibility you have. 19. Profit & Loss Statement See “Income Statement” above. 20. Statement of Cash Flow One of the important documents required by lenders and investors that shows a summary of the actual collection of revenue and payment of expenses for your business. The statement of cash flow should reflect activity in the areas of operating, investing, and financing and should be an integral part of your financial statement package. 21. Statement of Shareholders’ Equity If you have chosen to fund your small business with equity financing and you have established shares and shareholders as part of the controlling interests, you are obligated to provide a financial report that shows changes in the equity section of your balance sheet. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 7 22. Annual Percentage Rate The business finance term and definition APR represents the yearly real cost of a loan including all interest and fees. The total amount of interest to be paid is based on the original amount loaned, or the principal, and is represented in percentage form. When shopping for the right loan for your small business, you should know the APR for the loan in question. This figure can be very helpful in comparing one financial tool with another since it represents the actual cost of borrowing. 23. Appraisal Just like your real estate appraisal when buying a house, an appraisal is a professional opinion of market value. When closing a loan for your small business, you will probably need one or more of the three types of appraisals: real estate, equipment, and business value. 24. Balloon Loan A loan that is structured so that the small business owner makes regular repayments on a predetermined schedule and one much larger payment, or balloon payment, at the end. These can be attractive to new businesses because the payments are smaller at the outset when the business is more likely to be facing strict financial constraints. However, be sure that your business will be capable of making that last balloon payment since it will be a large one. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 10 31. Debt Consolidation If your small business has several loans with various payments, you might want to consider a business debt consolidation loan. It is a process that lets you combine multiple loans into a single loan. The advantages are possibly reducing the interest rates on the borrowed funds as well as lowering the total amount you repay each month. Businesses use this tool to help improve cash flow. 32. Debt Service Coverage Ratio The business finance term and definition debt service coverage ratio (DSCR) is the ratio of cash your small business has available for paying or servicing its debt. Debt payments include making principal and interest payments on the loan you are requesting. Generally speaking, if your DSCR is above 1, your business has enough income to meet its debt requirements. 33. Debt Financing When you borrow money from a lender and agree to repay the principal with interest in regular payments for a specified period of time, you’re using debt financing. Traditionally, it has been the most common form of funding for small businesses. Debt financing can include borrowing from banks, business credit cards, lines of credit, personal loans, merchant cash advances, and invoice financing. This method creates a debt that must be repaid but lets you maintain sole control of your business. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 11 34. Equity Financing The act of using investor funds in exchange for a piece or ”share” of your business is another way to raise capital. These funds can come from friends, family, angel investors, or venture capitalists. Before deciding to use equity financing to raise the cash necessary for your business, decide how much control you are willing to share when it comes to decision-making and philosophy. Some investors will also want voting rights. 35. FICO Score A FICO score is another type of credit score used by potential lenders for evaluating the wisdom of entering a contract with you and your business. FICO scores comprise a substantial part of the credit report that lenders use to assess credit risk. It was created by the Fair Isaac Corporation, hence the name FICO. 36. Financial Statements An integral part of the loan application process is furnishing information that shows your business is a good credit risk. The standard financial statementpacket includes four main reports: the income statement, the balance sheet, the statement of cash flow, and the statement of shareholders’ equity, if you have shareholders. Lenders and investors want to see that your business is well-balanced with assets and liabilities, has positive cash flow, and will have capital to make expected repayments. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 12 37. Fixed Interest Rate The interest rate on a loan that is established in the beginning and does not change for the lifetime of the loan is said to be fixed. Loans with fixed interest rates are appealing to small business owners because the repayment amounts are consistent and easier to budget for in the future. 38. Floating Interest Rate In contrast to the business finance term and definition fixed rate, the floating interest rate will change with market fluctuations. Also referred to as variable rates or adjustable rates, these amounts may often start out lower than the fixed rate percentages. This makes them more appealing in the short term if the market is trending down. 39. Guarantor When starting a new small business, lenders might want you to provide a guarantor. This is an individual who guarantees to cover the balance owed on a debt if you or your business cannot meet the repayment obligation. 40. Interest Rate All loans and other lending instruments are assigned the business finance key term interest rates. This is a percentage of the principal amount charged by the lender for the use of its money. Interest rates represent the current cost of borrowing. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 15 51. Secured Loan Many lenders will require some form of security when loaning money. When this happens, this business finance term and definition is a secured loan. The asset being used as collateral for the loan is said to be “securing” the loan. In the event that your small business defaults on the loan, the lender can then claim the collateral and use its fair-market value to offset the unpaid balance. 52. Term Loan These are debt financing tools used to raise needed funds for your small business. Term loans provide the business with a lump sum of cash up front in exchange for a promise to repay the principal and interest at specified intervals over a set period of time. These are typically longer term, one-time loans for start-up expenses or costs for established business expansion. 53. Unsecured Loans Loans that are not backed by collateral are called unsecured loans. These types of loans represent a higher risk for the lender, so you can expect to pay higher interest rates and have shorter repayment time frames. Credit cards are an excellent example of unsecured loans that are a good option for small business funding when combined with other financing options. 54. Articles of Incorporation This is legal documentation of the business’s creation, including name, type of business, and type of business structure or incorporation. This paperwork is one of the first tasks you will complete when you officially start your business. Once submitted, your articles of incorporation are kept on file with the appropriate governmental agencies. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 16 55. Business Plan Here is your tool for demonstrating how you want to establish your small business and how you plan to grow it into good financial health. When writing a business plan, it should include financial, operational, and marketing goals as well as how you plan to get there. The more specific you are with your business plan, the better prepared you will be in the long run. 56. Employer Identification Number (EIN) Certificate In order to be more easily identified by the Internal Revenue Service, every business entity is assigned a unique number called an EIN. When you start your small business, an EIN will be assigned and mailed to the business address. This number never changes, and you will be asked to furnish it for many reasons. 57. Franchise Agreement For a small business entrepreneur, entering into a franchise agreement with a larger company can be a way to enter the marketplace. The agreement made between you and the larger company gives you the right to operate as a satellite of the larger company in a certain territory for a given period of time. This lets you, the business owner, take advantage of a brand name that’s already familiar in the marketplace and a process or operation that has already been tested. 58. Net Worth This business finance term and definition is an expression of your business’s total value, as determined by your total current assets less the total liabilities currently owed by the business. With your business’s most recent balance sheet in hand, you can calculate the net worth using a simple formula: Assets – Liabilities = Net Worth. BIRMINGHAM BUSINESS RESOURCE CENTER 1500 1st Avenue North Suite B - 106/Unit 12 Birmingham, Alabama 35203 •. (205) 502-6350 17 59. Retained Earnings Just like it sounds, this term represents any profits earned that are retained in the business. This can also be referred to as bootstrapping. 60. Tax Lien If your business fails to pay taxes owed to the designated government entity, namely the IRS, you may find your assets seized by the claim of a tax lien. The government can not only seize your assets for liquidation to resolve the tax debt, but they can also charge you penalties on the amount you owe. Don’t Be Overwhelmed As a small business owner, you will be required to wear many different hats— often including that of chief financial officer or bookkeeper. Before you let yourself get intimidated by all the business terms and definitions, just remember that knowledge is power. You can serve your small business most effectively by becoming familiar with terms used in business finance and how they will affect your business’s financial health. Armed with a basic understanding of business finance key terms, you will be prepared to face the financial challenges that go along with being a small business owner.