Financial Terms for Business Owners

Financial Statement Terms

 Balance Sheet: The Balance Sheet shows what your business owns and what your business owes
at a “specific point in time” such as the date showing on the balance sheet. The following types
of accounts are located on the Balance Sheet:
o Assets: All the resources the business possesses, including cash, Accounts Receivable,
equipment, vehicles, inventory, raw materials, prepaid expenses.
o Liabilities: The claims against the above assets. Liabilities are what the business owes
creditors. It shows what your business owes the bank for any bank loans, the credit
card company, your family, the Dept of Revenue, for sales tax, the IRS, for payroll taxes
etc. Liabilities are usually divided by time horizon:
 Short Term Liabilities: Debt obligations that are scheduled to be paid within a
12-month period
 Long Term Liabilities: Debt obligations that are scheduled to be paid in a period
greater than 1 year
o Owner’s Equity/Net Worth: Owner’s Equity is the difference between the Liabilities
and the Assets. Hopefully you own more (assets) than you owe (liabilities), so your
equity in the business is positive.
o Retained Earnings: The cumulative net profits (or losses) that are left in the business to
accumulate. This represents the earnings that you have not taken out of the business in
the form of distributions or draws.
 Profit & Loss: The Profit and Loss Statement shows how much the business sold, how much the
costs in raw materials, product, and/or labor were and the expense you incurred to operate the
business. It also tells you if the business is generating a profit or a loss. The following types of
accounts are located on the Profit and Loss Statement.
o Revenue, Sales, Gross Sales, Gross Revenue: All these terms describe the dollar
amount that a business generates by selling its product or service. Revenue or sales is
typically the price of the product x the number of products or services that you sell.
Example: Sell 5000 units of Product X in a year, at $10 per unit and the Total Gross Sales
would be 5000 x 10=$50,000.
o Cost of Goods Sold: Also referred to as COGS, Cost of Goods Sold represents the
purchases of products that you resell, and/or raw materials that you use to make the
product, and/or labor to produce the product. COGS increases and decreases are
directly correlated with sales; the costs go up as the sales volume goes up, the COGS go
down as sales go down. Sometimes COGS are referred to as “variable costs”; they
“vary” with sales volume.
o Gross Profit (or Loss): Gross Profit (or Loss) is the difference between Sales and COGS.
The gross profit represents the amount that is made (or lost) on the sale of the company
product or service.
o Gross Margin: Gross Margin is typically stated as a %. It’s calculation is gross profit
divided by sales. It represents the % of each sales dollar that remains (after paying for
 product, raw material and production labor) to contribute to the remaining operational
expenses and profit.
o Operational Expenses: These are the expenses incurred to operate the business.
Operational expenses are things such as rent, utilities, office supplies, insurance, wages,
telecommunication, supplies, janitorial services etc.
o Depreciation: Depreciation is a non-cash expense. Depreciation is the portion of your
fixed assets that are expensed each year. The expense represents the amount of asset
that is “used up” during the year. Whether and how an asset is depreciated is typically
governed by current IRS tax code.
o Net Profit (or Net Loss): Net Profit is the difference between Gross Profit and
Operational Expenses. If the Operational expenses are less than the Gross profit, the
business will have a net profit. If they exceed the gross profit, the business will have a
net loss.

Statement of Cash Flows: The statement of Cash Flows is a combination of information from the Profit
and Loss and information from the Balance Sheet. It shows how cash “flows” through the business. It
shows the starting cash of the business. It shows how the business operations (sales and expenses)
increased or decreased the cash in the business throughout the period. It demonstrates how the
changes in accounts receivable and accounts payable add to cash or decrease cash? Sometimes a
business will show a Net Profit on the P&L but have no cash! What happened to the cash? The
Statement of Cash Flows answers this question.

Miscellaneous Financial Terms

Unit Cost: The cost to the company of purchasing or providing a unit of product or service. This could be
labor unit cost or item unit cost or an average cost per plate.

Capital Expenses: A capital expense is a tax term used to describe a purchase of or expenditure for an
asset, or an upgrade to an asset, that has the expectancy of producing benefit to the business for longer
than one year.

Cash vs Accrual Accounting: This term describes the different types of accounting methods. The
difference is related to the timing of when expenses and revenue are recorded.

 Cash: This is a system of tracking (recording) income and expenses based on when the cash is
exchanged or spent. Cash accounting records the revenue when the “cash” is received and
records the expense when the expense is paid.
 Accrual: This is a system of tracking (recording) income and expenses when income is “earned”
or expenses when they are “incurred” rather than when “paid” Accrual accounting records the
revenue when it is “earned”, even though no cash has been received (thus creating an Accounts
Receivable). Accrual accounting records the expense when the expense is “incurred” even if no
payment has been made for the expense (thus creating Accounts Payable).
Breakeven: The sales point (volume, $$ amount etc.) at which the all fixed and variable expenses are
met, but there is no profit and no loss.

 Fixed Expenses- Those expenses that are regular operational expenses that typically occur every
month whether you have sales or not such as rent, insurance, cellphone, internet
 Variable Expenses-Those expenses that fluctuate with the volume of sales that you make.
Variable expenses rise and fall in sync with sales. If you don’t have the sale, you don’t have the
expense. Examples of variable expenses are costs such as product cost, raw materials cost etc.

Tax Accounting vs Book Accounting:

Book accounting describes the company financial information before Federal tax benefits are taken. It’s
the information that businesses typically report to shareholders, and bankers. Book accounting
standards are typically more stable (called Generally Accepted Accounting Principles or GAAP) and less
changeable from year to year. It allows the business to see how well the company is performing month
to month and year to year.

Tax accounting is typically handled on the tax return. The accountant starts with the book accounting
records and adjusts allowable by tax law, such as accelerated depreciation, Section 179 adjustments. Tax
law typically changes from year to year. Some businesses want their Book Accounting to match their
Tax Accounting by adjusting their books with year-end adjustments that their tax accountant has made.
Other businesses leave their Book accounting as is and don’t make these adjustments to their books as
they want to ensure their books represent the actual performance of the business, uninfluenced by
changing tax law.