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Basic Financial Terms Every Business Owner Should Know

Basic Financial Terms Every Business Owner Should Know

“You keep using that word. I do not think it means what you think it means.”

~ Inigo Montoya, The Princess Bride

It’s entirely conceivable that you’ll encounter some utterly mystifying financial jargon when you talk to your bank representative, financial advisor, or accountant. We’re not trying to confuse you on purpose; we use industry-specific words often because they represent specific concepts.

Imagine how awkward a conversation would be if we said things like, “Well, your assets that we expect will be turned into cash within a year are high enough that we expect that it won’t be too difficult to pay your obligations to vendors and other service providers which will come due within the next year. It would be much easier to say that “Your Current Assets are high enough that we expect it won’t be too difficult to pay your Accounts Payable.”

Because we genuinely do want everyone to be able to understand these basic financial terms, we’re going to cover a bite-sized set of basic financial terms definitions that every small business owner should know (or really in our opinion, that everyone should know). Let’s split it into a few different categories:

  1. Balance Sheet Terms: things your business owns and things it owes.
  2. Profit & Loss Terms: things your business earns and things it pays.
  3. Tax Terms: the unfortunately complicated set of taxes that every business must pay

Basic Financial Terms: Balance Sheet

Basic Financial Terms_ Net Worth Definition

Your Balance Sheet is the document that lists things that your business owns and things it owes (followed by a section entitled Equity that we will cover later).

It makes intuitive sense that owning something is the opposite of owing the same thing: the first is “positive” and the second is “negative.” We frequently use the term net worth, which is all the things your business owns (assets) minus all the things it owes (liabilities). But there are different kinds of assets and liabilities which we will define in plain English below:

Assets

Assets are the things that your business owns, but there are a lot of different kinds of assets. Thankfully many of them can be understood in terms of opposites. Assets are either Current or Non-Current, and they are either Tangible or Intangible. Let’s start with Current Assets which we will define below:

Current Assets

Financial terms definitions you should know
Financial terms definitions for small business owners

Current assets are items that your business owns that are generally expected to be liquidated (turned into cash) within a year. In the financial industry we use the term cash more broadly than you might expect. To us, cash includes hard currency (physical dollars and cents), money in your checking account, money in your savings account, and checks that you can deposit. We also use the term cash equivalents to mean other cash-like current assets you might own, like Treasury bills and Money Market funds. Cash and cash equivalents are often lumped into the same category on the Balance Sheet.

Of course, there are current assets besides cash because there are other items that your business would expect to liquidate within a year. For example, Accounts Receivable — all the money that your customers owe you in the short term — also count as Current Assets.

Other Current Assets include:

  • Prepaid Expenses (which thankfully does mean what you think it means)
  • Deposits (which are pretty much the same as Prepaid Expenses)
  • Inventory (if your business does any manufacturing)
  • Supplies (items that your business uses that are incidental and not worth closely tracking, like paperclips, disposable gloves, or printer paper)
  • There are other Current Assets as well, but you get the idea

Because Current Assets are relatively easy to liquidate, they are sometimes also called liquid assets, although we don’t use that term often at TL;DR Accounting.

Non-Current Assets

Alright, time for one of our favorite definitions of all time. Non-Current Assets are assets that are not Current Assets. How delightfully circular! Okay, the real definition is more like this: Non-Current Assets, also known as Long-Term Assets or Fixed Assets, are things your business owns that are not expected to be liquidated within a year.

Financial terms definitions for small business owners

You probably have an intuitive understanding of what kinds of things fall into this category. Here is our non-exhaustive list:

  • Real estate (Land and Buildings, pretty self-explanatory)
  • Equipment (which, in the financial industry, specifically means expensive equipment that is expected to be used over several years. We’re not talking about wrenches and measuring tape here.)
  • Furniture over a certain dollar amount

As you might have guessed, there’s an extra element to Non-Current Assets. Generally it only includes items that are priced over a certain dollar amount. Why is this? Well, most Non-Current Assets are depreciable; in fact most Non-Current Assets (notably excluding Land) are also known as Depreciable Assets.

Depreciation is a way to numerically tally the “using-up” of an asset. Let’s say you have an x-ray machine that you expect you’ll get about 5 years of use out of. Every year you will depreciate 20% of the asset’s purchase price. If you sell or dispose of the machine before 5 years, that’s fine; nobody’s going to arrest you for upgrading a depreciable asset before its time. It’s also fine if you keep using it longer than 5 years — don’t worry, we won’t nag you about that. It will just be known as a “fully depreciated asset.”

Now you might be wondering what depreciation has to do with expensive assets. Basically, it’s just not worth bothering with the whole depreciation math when it comes to your $5.99 stapler (or even your $30 red Swingline stapler just like Milton’s from Office Space). According to the IRS, it’s not worth bothering to track and depreciate any asset valued less than $2,500. But you can set a higher depreciation threshold than $2,500 as long as you have a written depreciation policy.

Tangible and Intangible Assets

In short, Tangible Assets are assets that you can touch, and Intangible Assets are like M. C. Hammer — you can’t touch them. Even if you’re not allowed to touch a tangible asset (like the baler machine in the show The Office), it still counts as tangible because it is technically possible for a person to touch.

You might be wondering why it’s important to make this distinction. Well, it’s because intangible assets are generally not depreciable. A patent for an automobile isn’t going to suffer wear and tear like a physical automobile. Now, there are rules for writing down patents if they’re no longer as valuable as they were (but that is beyond the scope of this article). Of course patents will expire, at which point they no longer have any value on the balance sheet.

Liabilities

Basic Financial Terms_ Liabilities Definition

Liabilities are debts that your business owes. If it helps, you can think of them like “asset-sized holes” in your business’s Balance Sheet. They can be categorized as Current Liabilities or Long-Term Liabilities in the same way as Assets, except that the timing relates to when they must be paid. Note that we say when they must be paid, nobody is going to arrest you for paying a Long-Term Liability within a year (although prepayment penalties may exist in the loan contract). One wrinkle here is that, generally speaking, you will owe a portion of your long-term liability within a year. This is called the Current Portion of Long-Term Debt and is listed on the Balance Sheet as such.

Unlike Assets, Liabilities are all intangible. As much as you might love to, you can’t destroy your auto loan. Sure, you can shred the paper it’s written on, but the loan itself still exists (and you better believe the lender has an electronic copy of your loan on file).

Typical Current and Non-Current Liabilities that you might have on your business’s Balance Sheet include:

Current Liabilities:

  • Accounts Payable (amounts owed to vendors for products and services that you have purchased)
  • Credit Card Debt
  • Wages Payable (wages that you owe but haven’t yet paid to your employees)
  • Current Tax Liabilities (taxes that have already been calculated, that you owe within a year)
  • Current Portion of Long-Term Debt (as explained above)

Non-Current Liabilities:

  • Notes Payable (generally, bank or governmental loans that will be paid over several years)
  • Mortgages (which function much the same as Notes Payable except that they have real estate as collateral)
  • Leases (amounts owed for renting an asset such as a forklift or other kind of equipment)
Basic Financial Terms_Equity

Equity

In short, Equity is the portion of your business that you own for yourself, which is calculated as your business’s Assets minus its Liabilities.

Basic Financial Terms: Profit & Loss Statement

The terms you will see as stated on your Profit & Loss statement will be more self-explanatory than those on the Balance Sheet. To start, the Profit & Loss Statement (P&L), also known as the Income Statement, lists your Revenues and Expenses over a certain period of time: often a month, quarter, or year.

Revenue, also known as Income or Sales, is the amount that your business earns “on paper.” This should not be confused with the cash that your business brings in. While revenue and cash inflow are related, they’re not the same thing! The fact that your customers owe you $1,000 isn’t going to help you make rent next week.

While the distinction isn’t often made in QuickBooks, Revenue can be divided into Operating and Non-Operating Revenue. Operating Revenue is the revenue your business earns from conducting its primary activity — providing therapy for a therapy office or selling cookies for a cookie manufacturer. Non-Operating Revenue, naturally, is the opposite. The interest revenue that your business earns on its savings account is Non-Operating Revenue.

Non Operating Revenue Definition

The definition of an Expense is pretty self-explanatory. There are Operating Expenses and Non-Operating Expenses just like with Revenue. For manufacturing firms, Cost of Goods Sold (COGS) is a special type of expense that relates to only the costs involved with making a product. Chocolate chips, production floor wages, and gas for the cookie ovens would all be COGS for a cookie manufacturer.

When you subtract Expenses from Revenue, you get Net Income or Net Profit. Note that Net Income is not the same as Gross Income. If someone mentions “Income” without specifying whether it’s Gross Income or Net Income, they could mean either. If it’s unclear, ask!

A Quick Note on the Statement of Cash Flows

As Net Income is different from cash inflow, there is a specific statement separate from the P&L that shows how your cash moves called the Statement of Cash Flows. This statement is probably one of the most intuitive reports that you will see for your business, but it is important to specify the types of cash flows:

  • Operating Cash Flows are cash earned and paid for business operations, in the same sense as Operating Revenue and Operating Expense.
  • Investing Cash Flows are for equipment that is purchased or sold, because they relate to you investing in the future of your business.
  • Financing Cash Flows, naturally, are for financing your business. These are mainly outflows for loans, but can also include inflows from stocks and bonds.

Basic Financial Terms: Taxes

When it comes to anything tax-related, we readily recommend seeking an expert. But it certainly wouldn’t hurt to know the definitions to some common tax terms that we will often talk to you about.

Federal Estimated Taxes

If you’re a new business owner or newly self-employed, it’s possible that you have never had to pay Federal Estimated Taxes because your tax withholding has always been handled for you through your employer. Withholding is money that is paid to the IRS before the end of the year, which the IRS keeps until you file your taxes. The point of withholding is that the IRS will penalize you if you haven’t pre-paid enough of your taxes in a timely manner. This might seem unfair, but it’s out of our hands.

What are withholdings? Definition of common financial terms

Specifically, the IRS will penalize you if you pay less than 90% of your taxes owed this year, or 100% of the taxes you paid the previous year, whichever is smaller*. While it’s clear what 100% of the taxes you paid previously are, maybe you don’t want to (or can’t afford to) pay that much. Maybe business isn’t going as well this year as it did last year.

[* The 100% changes to 110% if your Adjusted Gross Income is $150,000 or more]

Federal Estimated Taxes are a way that you may be required to estimate your own withholding and pay it to the IRS yourself. Whether or not you are required to pay estimated taxes is a good question for us to answer for you on a case by case basis (give us a call!). Believe us, it’s not a simple process.

You pay your Federal Estimated Taxes four times a year using form 1040-ES. These forms (and the attached payments) are due April 15th, June 15th, September 15th, and January 15th of the following year. Generally speaking, each payment is an amount equal to 25% of what your total payment will be, but your estimates (and hence payments) may change during the year.

Washington State B&O Tax

As if Federal taxes aren’t enough of a headache, Washington businesses are also expected to file Business & Occupation (B&O) Tax. Other states have similar requirements. B&O Tax is generally a tax on the Revenue that your business makes, and it is paid either Annually, Quarterly, or Monthly depending on your income. The Washington State Department of Revenue (DOR) will tell you if you need to increase your filing frequency. If you want to file less often because your revenue has fallen, you can request this by contacting the DOR.

We can help you set up an account to pay your State B&O Tax, as well as your city B&O tax if you have one (Seattle has one). We can also file your B&O tax for you every time if you like — just let us know!

TL;DR: If you want to feel more empowered during financial conversations, try learning some of the key basic financial terms listed in this article. It will make conversations with your financial professionals go just a bit smoother. Here’s one last freebie: “TL;DR” means “Too Long; Didn’t Read,” a fitting acronym for this day and age of information overload!

Have another question for us? You can reach out to our friendly accountants any time over on this page.

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