Every industry has its own jargon, terms, or specific language, and accounting is no different.
This blog aims to accomplish two tasks for you: help you understand a few common accounting terms so you can be on the same page and communicate more easily with the financial professionals in your life, and provide you with the necessary information to address your finances properly. From cash flow to burn, we’re here to teach you what you need to know to grow your business's wealth.
Assets are all resources that a company owns. These resources, in most cases, are crucial for daily operations. For example, a restaurant needs its kitchen equipment to generate revenue. Without functioning refrigerators, ovens, or prep counters, a restaurant is as good as closed. So, those are assets. It’s more than just equipment, though. Product inventory, brick and mortar locations, vehicle fleets, and even your cash on hand and receivables are all considered assets!
Think of liabilities as debt. It’s a more specific term for the amount of money owed. Liabilities include but are not limited to credit payments, accounts payable, loans, and taxes.
Cash flow is a low-level look into the volume of cash entering and leaving a business at a specific point in time. It’s usually the sort of thing to look at in the moment to better understand what you can afford right now.
Cash flow reports help businesses determine whether they have the cash on hand to get the job done right now. Can you afford a new appliance? Are you able to pay for an emergency repair? It doesn’t matter how profitable a business is. No cash means you’re in trouble. This is one of many tools that accountants use to anticipate and avoid that trouble.
Once you understand cash flow reports, you can begin identifying trends between cash flow reports on a monthly or quarterly basis. As you begin to track your income and expenses, over time you’ll see your cash flow trends and be in a better position to estimate how much money comes in and how much goes out for a given period of time. This information helps you make smarter business decisions. Big project coming up? Thinking about moving or opening a second location?
Generally, cash flow forecasting can be done several times per year, depending on business scope and industry.
Profit is a word that can mean a few different things. If you’re not careful, you can confuse profitability with how much money your business actually earns.
Gross profit is calculated by subtracting the direct cost of fulfilling a service for customers from your total revenue. Let’s go back to that restaurant we mentioned earlier. It’s a good one. Makes pretty tasty sandwiches. If the restaurant can produce their most popular sandwich at $10 but sells each sandwich for $15, then the gross profit on that sale is $5.
This cost includes general administrative and operating expenses such as rent, utilities, telephone, etc. Don’t make the mistake of confusing gross profit with net profit.
Once you have a firm grasp on your gross profit, both projected and actual, you can begin focusing on how to optimize your net profit.
Do you know how long you can cover your operating costs without earning a profit? That’s your burn rate. You can also think of burn rate as negative cash flow, or how much cash you’re able to spend without more coming in. This rate is necessary for startups to fund their own operations or receive investments. A burn rate answers the question, how long can your business survive without making a profit?
The goal of calculating burn rate is to determine whether your business is self-sustaining. Burn rate is one of the few accounting metrics where a negative number is actually a good thing! To calculate your business’s net burn rate, first select an amount of time, then subtract your cash balance at the end of that time period from your beginning cash balance, and divide that number by the number of months.
You know what breaking even means. A break-even analysis is a formal reporting process that determines the point at which your business income matches your expenses for a task, product, or rendered service.
Just because you have a burn rate, doesn’t mean you can understand it. A Break-even analysis does that. It’s how you’ll be able to make informed decisions around how much to charge for a product or service so that you can break even, and then some!
The goal is a profitable business, and a break-even analysis helps you get there.
Overhead expenses include all of the hidden costs of doing business. The bills most people don’t even think about. Labor, clerical supplies, software, insurance, or technology are just some of the expenses that can really add up if you’re not careful.
There is a cost to doing business, that is true. Gotta spend money to make money. Just don't use that motto as an excuse to waste money too. Otherwise, you'll find yourself in a hole you can't dig out of.
Overhead expenses are often fixed, instead of dynamic and ever changing. While profits ebb and flow, overhead costs are much more predictable. You usually have direct control over these expenses, regardless of profitability or ROI.
Knowing these terms will help you better communicate with a dedicated CPA in your corner. Whether you’re a business owner that prefers to hand your books off to a trusted partner or work in tandem with your CPA, we have you covered. Thanks to this blog, we hope you’re a little more prepared to be financially savvy.
We crunch the numbers, so you can focus on business growth. That’s why over 300 clients turn to Chaliff + Associates every year for their bookkeeping and accounting needs. Request a consultation today to learn why a dedicated CPA is right for you and your business.