Know the Numbers and Be In Control of Your Business Finances

Understanding financial terminology and being able to interpret simple financial statements is key to a healthy small business. I am not advocating that you take on the tax filing, although you might be able to… but being being capable of simple bookkeeping and reading your financials will allow you to make sound financial decisions and determine which parts of your business might need attention.

Three of the most important skills for a small business owner are simple bookkeeping, budgeting and the ability to interpret a profit and loss statement. You can learn a bit more about bookkeeping here. These skills are all attainable and with a little work, you can learn how to take control of your business’ finances and drive profits for yourself.

SOME FINANCIAL LITERACY TERMS YOU SHOULD KNOW

As Maria Von Trapp would say, we have to start at the very beginning! For me, the beginning is vocabulary. Below are some terms that will help you understand your finances.

GROSS INCOME

Gross income is the sum of all of the cash brought in by your business. Most businesses have several revenue streams. As a travel agent, some of your streams could be commissions from different suppliers and/or other professional fees you charge. It is important to categorize your income so you can assess where most of your money is coming from and capitalize on that knowledge.

NET INCOME

Net Income is your Gross Income minus all costs. Net income is how much profit or loss your business makes in a certain time period.

COST OF GOODS SOLD (COGS)

Your COGS are the total costs of all of the materials and labor that are directly required to provide your services to your clients. These include things like printing, employee salaries and even your time. If you offer a promotional item for your clients, this would count as a cost of goods sold.

OPERATING EXPENSES

Operating Expenses are expenses that your business pays for day to day operations that you have to pay regardless of whether or not you are making a sale. Things like your insurance expenses, equipment rentals, subscriptions to apps, monthly or annual professional fees and even your annual licensing costs. Generally operating expenses are expenses that have contracts that are less than one year and cannot be attributed to a single business output or product.

CAPITAL EXPENDITURES

A Capital Expenditure is money that you’re spending for the future benefit of your business. Capital Expenditures can be a lot like an Operating Expense, as they are not attributed to a single product, but they differ in that the item or service you’re purchasing will last for years to come. Some good examples are legal services for business formation, graphic design services for your logo or website design.

GROSS MARGIN

Gross Margin is the amount of money it costs to generate your revenue, represented by a percentage. It is your Net Income - Cost of Goods Sold. Calculating your gross margin will give you an idea of whether or not you’re generating more money selling your product than it takes to make your product. You can also use your Gross Margin percentage to make decisions about how much money you will have left over after you pay for the costs of your product, you can then determine if you want to use that money to put back into the business as OPEX and CAPEX or keep as profit.

PROFIT MARGIN

Profit Margin is the percentage of Gross Income that ends up as Net Income. For example, if your Gross Income is $1000 and your Net Income is $300, you have a 30% Profit Margin. This information is handy to know because you can set a goal of a certain percentage of margin for your company and tweak your costs or revenue streams to meet your goal. You can research typical margins for your industry to get an idea of a goal to set for yourself. In general, a margin in the single digits can be a sign that you need to make a change.

CASH FLOW

Cash flow is the amount of money that comes into and goes out of a business in a specific period of time. This is different than profits, because cash moves asynchronously to sales and income. Positive cash flow means you’re bringing in enough revenue to meet all of your obligations. Negative cash flow is when you are bringing in less revenue than your bills.

BURN RATE

Burn Rate refers to the amount of cash that it takes for your business to operate for a specific period of time. Most often, the time period is a month. All businesses have overhead expenses, even if it is just the money it costs to keep your website running. Especially in an industry that works on delayed commission, you need to know how much cash it takes to keep your “lights on” month to month so you have a nest egg saved up for when cash flow is tight or when you’re waiting on commissions.

ASSETS

Assets are your cash, equipment, real estate, merchandise and supplies that your company currently has on hand. Basically, everything that your company itself has as value. Be sure not to conflate your personal assets with your business assets, for example: your laptop - did you buy it personally, or did the business purchase it for you? If your answer is the former, it is a personal asset, not a business asset. Assets are listed on a report called the Balance Sheet.

One of the best ways to keep your business and personal finances separate are with a business bank account and business credit card, you can learn more about how to set up separate finances here.

LIABILITIES

Liabilities are the opposite of assets, your liabilities include any outstanding debts, loans and credit card balances. If you have a brick and mortar business, or if you have a standing lease or a utility contract for your business, your rent and utilities are also included in your liabilities. Liabilities are listed on a report called the Balance Sheet.

THE PROFIT AND LOSS STATEMENT

Your total profit (or loss) is represented in a Profit and Loss Statement on the bottom line of the report and is called “Net Income. A Profit and Loss Statement, in its simplest terms, is the amount of money made minus what you spent. Gross Income - (Costs of Goods Sold + Operating Expenses + Capital Expenditures) = Net Income. If your net income is negative, that means your business lost money over all, if it is positive, that is the total profit from your business for the time period in question.