Managing your business’s finances can be challenging if you have a limited background in that field. There are numerous complex concepts many owners have a hard time understanding, which are very important.

We want to explain some accounting and financial topics that may be confusing but are essential to effectively overseeing your business’s fiscal health.

Operational Costs

The following terms should help you understand how to organize your business’s spending:

Working Capital

This is the amount of money you have available to run your business day-to-day. To calculate, subtract your current assets — the cash and items your business possesses — from your current liabilities, or what your organization owes to others.

Cost of Goods Sold (COGS) and Cost of Services (COS)

COGS and COS are the total costs of producing goods and operating services your business sells.

It is essential to understand your COGS and COS precisely to know how much cash you have left to cover other expenses. Do your best to anticipate all possible costs and be prepared for unexpected ones.

Fixed Costs

These are expenses that occur regularly on a routine or cyclical basis. The rate is usually the same or “fixed” for the entire duration you pay for the product or service.

Examples include lease payments, insurance, salaries and other utilities.

Variable Costs

These are expenses that change frequently — week-to-week and month-to-month.

Examples include raw materials, hourly labor and packaging.

Key Financial Statements

There are four main financial documents you should use to monitor the overall financial health of your business:

Income Statement vs. Cash Flow Analysis

The income statement shows the bigger picture of total earnings and spending — including sales, investments, expenses and losses. The cash flow statement represents liquid health and is a better indicator of your business’s day-to-day financial state.

• Income Statement – This document is also known as a profit and loss (P&L) statement. It provides a comprehensive financial summary of your business’s revenues and expenses during a particular period. Usually organized by month or quarter, the cumulation of these numbers is meant to show net profit or net loss.
• Cash Flow Statement – Cash flow is how money moves in and out of your business. It is arguably the most important financial aspect of running your organization. The cash flow statement is meant to tell the full story of how your business makes and spends money, tracking every dollar that flows in and out on a short-term basis.

Balance Sheet

This document provides another summary of your business’s short-term financial health, presenting your assets, liabilities and equity. It can help you determine your organization’s ability to pay debts and expenses and show levels of cash on hand to attract investors.

Owner’s Equity Statement

This report shows the difference between total assets and liabilities, which results in the overall value of the owner’s equity.

To gain a more comprehensive understanding of all four documents and how to use them to evaluate your business’s financial standing, this guide from TD Ameritrade explains how they work together. From this guide, you can access individual webpages for each statement type with examples and templates you can download.

Important Metrics

Here are a few data points you should measure to help you understand how your business earns and spends money:

Economic Units

Economic units are revenues and expenses related to a quantifiable product used to determine unit profitability — most businesses use a single customer as a unit. 

To calculate a consumer's unit profitability, subtract the customer acquisition cost (CAC) from the customer lifetime value (LTV).

Understanding economic units and how to analyze them can help you forecast profits, optimize your products and assess your market sustainability.

Cash Burn Rate

This is the speed at which your business spends its available cash. It is often measured on a monthly basis. To calculate, you divide the amount of cash you have on hand by your monthly operating expenses.

Cash Runway

This metric states how long your business can operate with its existing cash on hand. The formula for this metric is to divide the total cash you have divided by your burn rate.

Cash vs. Accrual Accounting

These two concepts explain the difference in time frames when money is brought in and paid out.

Cash Accounting

This recording of revenue and expense transactions is done when money is earned or received, and it is actually paid.

Accrual Accounting

This metric records revenue and expenses when transactions are set in motion — such as when they are billed but not paid yet.

Understanding the difference between these two accounting types will help you more accurately evaluate your cash flow and make better-informed accounting decisions.

Resources

These topics are only the beginning. So, we’ve linked a couple of sources to help you gain a more in-depth understanding of business accounting and financial concepts you must be able to comprehend:

• Finance Experts Share 14 Financial Concepts Every Small-Business Owner Must Understand
• 16 Financial Concepts Every Entrepreneur Needs to Know

If you found this article informative and helpful, visit americanbusinesscoalition.info to learn more about how the American Business Coalition can support you.