When you’re looking at how to start a business, some terminology may be unfamiliar to you. And while you don't need a formal education to be successful in the business world, even if you’re great at what you do, it’s important to know certain basic business concepts.
Here’s a quick-reference list of common business terminology. Understanding these 33 terms and phrases will help you manage your finances, streamline your operations, and formulate your strategy.
Business terminology: 33 key terms and phrases to know
Accounts payable are short-term debts owed by a small business. These may include bills for utilities, inventory received, or services rendered. It is important to know how much your business owes in the short term so you can manage your cash flow to ensure bills are paid on time.
If a business sells an item or service on credit to a customer, the amount due would be classified under accounts receivable. Accounts receivable do count as an asset, but it’s important to track total days a sale is outstanding. Watching this number closely will help you determine which customers are paying in a timely manner and which accounts need some extra attention.
Accrual vs. cash-based accounting
Accrual-based accounting tracks income and expenses when you create invoices, whether or not money changed hands. While cash-based accounting includes income and expenses only when customers make payments or vendors are paid.
As a business owner, you need to decide which method works best for you. Each option has its pros and cons, with potential tax implications. For example, assume that you sold products to a customer in December, but did not get paid until January. Under accrual-based accounting, you would owe taxes on the revenue in December, even though you didn't collect payment until January. With cash-based accounting, if you purchased supplies from a vendor in December, but didn't pay until January, you would not deduct the expenses until you paid for them.
Assets are the items a business uses to conduct business, such as equipment, inventory, and intellectual property. Not all assets are physical goods because things like patents and copyrights are also valuable parts of your business.
A balance sheet shows the relationship between your business’s assets, liabilities, and equity as of a specific date. The document breaks assets and liabilities into current and long-term items. Businesses strive to increase their assets and equity while reducing liabilities. Keeping your balance sheet up-to-date will help you better understand current and future cash flow.
Many small business owners have “bootstrapped” the funding of their business. This means that they invested their own money and used personal credit to pay for business expenses as it ramps up to be self-sustaining. Business owners choose this method to avoid debt or because they are unable to get business financing.
A business's break-even point is when its total revenues equal its expenses. This number is important to know so that you understand much revenue is needed before you can start making a profit.
Just like we have a personal credit report and score, so do businesses. Business credit reports and scores are available from Experian, Equifax, and Dun & Bradstreet. A business credit score becomes more important as the business grows and requests approval for leases, larger business loans, and letters of credit.
Business credit card
Business credit cards are similar to the personal credit cards that you use for everyday expenses and earning rewards. These credit cards often have different bonus categories that reward cardholders for common business expenses. In many cases, you can apply for a business credit card to earn additional bonuses and combine the rewards with your personal rewards accounts.
It is important to note that the 2009 CARD Act does not cover business credit cards. Therefore, they do not have the same mandatory consumer protections that personal credit cards offer. For example, the rate on an existing balance of a personal credit card cannot increase unless you've missed two consecutive payments. Lenders are not required to offer this protection on business credit cards.
When starting a new business or looking to expand a current one, creating a business plan helps solidify your strategy. This document is often used to attract investors or request a loan. Business plans detail your core competencies, serve as a roadmap for your business, and include projections forecasting your financial performance.
Cash flow statement
Your cash flow statement is a document that summarizes the flow of cash in and out of the business for a period of time. The document shows the beginning and ending amount of cash available and uses categories of operations, investing, and financing. Business owners rely on the statement of cash flows to see where the money comes from and where it goes.
A C-corporation is a legal entity with two or more shareholders and its own Employer Identification Number (EIN). C-corporations pay federal taxes at the entity level. Distributions to shareholders are also taxed, which creates the potential for "double taxation."
Shareholders of C-corporations have limited risk with this organizational structure because the maximum that they can lose is the amount of money they’ve invested. Keep in mind that the debt of a C-corporation may still require a personal guarantee to protect the lender.
Cost of good sold (COGS)
If you sell products, the cost of goods sold is the total cost associated with buying or building what you sold. This includes both the raw materials and the labor associated with manufacturing the product. The difference between your sales price and COGS determines how much money you keep as profit.
When a business buys an asset, the asset has a useful life expectancy before it must be replaced due to wear and tear. Instead of assuming that the asset retains the same value throughout its life, depreciation reduces the value incrementally each year. Depreciation expense reduces the profitability of a business, even when no money is spent, to account for the reduction in the value of that asset. Accumulated depreciation is a balance sheet item that totals the amount of depreciation expensed over the assets lifetime.
A fixed cost is an expense that does not change over the short term. The fixed costs of a business are the expenses you will incur whether you produce or sell any items or not. Examples of fixed costs include rent, salaries, and insurance.
The income statement summarizes the revenue, expenses, and net profit of your business over a specific timeframe. Common periods for this report are monthly, quarterly, and annually. Business owners can customize this report by company division, geographic region, product type, or other criteria to analyze and compare the performance of their company.
Inventory is the value of finished goods that a business has available for sale. The inventory is purchased from a supplier or manufactured by the business from raw materials. Inventory is recorded as assets on the balance sheet. When items are sold, they are removed from inventory, then counted toward the cost of goods sold.
Business owners try to find the right balance for their inventory. They want enough inventory to satisfy the demands of customers. However, too much inventory is a risk because it can go bad, become outdated, or get broken, lost, or stolen. Businesses conduct inventory counts on a periodic basis to ensure that their records match the actual inventory on hand.
A lease is a contract to use an asset for a specified period of time in return for payment. Businesses often lease an office or a building, equipment, or software to run their operations. Leases usually have a lower payment than a traditional loan because the asset is returned to the lessee at the end of the lease.
The lower payments of leasing an asset improve cash flow in the short term when compared to buying an asset. Lease payments are also treated differently for tax purposes than a loan to purchase an asset.
Liabilities are the sum of all monies owed by a business. They are categorized as current or long-term liabilities, with current liabilities due within one year. Long-term liabilities include loan payments, capital liabilities, deferred compensation, and customer deposits.
Business owners focus on liabilities to prepare for payments coming due in the short-term and create long-term plans to repay debts into the future.
Limited Liability Company (LLC)
A limited liability company is a corporate structure where owners are not liable for the company's debt. It is possible for an LLC to be owned by a person, corporation, other LLCs, and foreign entities. LLCs may elect to be taxed as a corporation, a partnership, or as part of the owner's personal tax return.
Long-term debt is a liability that will be paid back over a period longer than one year. Businesses sometimes borrow money over several years to finance larger assets or take advantage of financing opportunities. Examples of long-term debt are commercial real estate loans, equipment leases, pension benefits, and contingent obligations.
A net loss occurs when business expenses are greater than revenue. When a business first opens, it is common to have net losses due to startup expenses and efforts to grow revenue. If a business loses money, business owners make up the difference by drawing down business savings, borrowing, extending its accounts payable, or contributing more money from personal accounts. If the business continues to lose money, the business owner should re-evaluate its business plan to determine if the company is viable.
Operating costs are the ongoing expenses of a business that are part of its normal functions. These expenses include the cost of goods sold and operating expenses, such as sales expenses, travel, bank service charges, office supplies, utilities, and rent. Operating costs include both fixed and variable expenses of the business.
Revenue minus operating costs equals operating income. This is not the same as net profit because it does not include finance charges like interest expenses.
Overhead refers to the non-labor expenses required to operate your business. These expenses are not linked to the manufacturing of a business's products or providing services. Knowing how much overhead a business has helps to determine how much a business owner should charge customers.
Owner equity represents the owner's net investment in the business since the company began. Subtract liabilities from assets to calculate owner's equity. The number increases when the company makes a profit or the owner contributes money or assets to the business, and it decreases when the company loses money or the owner makes a withdrawal from the business.
A partnership is an agreement between two or more people to operate a business together and share its profits. The partnership may or may not have formal documents describing the agreement. Partnerships do not pay taxes at the entity level. Profits and losses pass through to partners equally unless otherwise stated.
There are different types of partnerships, such as general partnerships, limited partnerships, and limited liability partnerships. Each type has different pros and cons based on your business arrangements and goals.
Although many small businesses have their own credit report and score, a lender may require a personal guarantee from the owners in order to guarantee a loan. A personal guarantee holds the owner responsible for a business debt in case the business is unable to make payments. In most cases, when you apply for a business credit card, loan, or lease, as the owner, you will personally guarantee the debt.
A profit margin is the measure of a company's profitability. Subtract all expenses from revenue to equal profit margin. If the number is positive, the company made a profit. However, if it is negative, the company operated at a loss. Business owners try to increase their profit margin by increasing prices, selling more items or services, and reducing expenses.
Return on investment (ROI)
The return on investment (ROI) measures how an investment performs. You calculate ROI by dividing a company's net profit by the total investment multiplied by 100%. For example, a $1,000 profit on a $10,000 investment would be a 10% return. It is important to track your ROI so that you can evaluate the performance of your investment into the business compared with alternative investments you could have made instead.
An S-corporation is a special type of corporation with less than 100 shareholders. It provides the limited liability benefits of a corporation while allowing the profits of the company to be distributed and taxed as a partnership. This tax designation directly addresses the concerns of "double taxation" of a C-corporation. Shareholders of S-corporations must be individuals, specific trusts and estates, or certain tax-exemption organizations.
A sole proprietorship is the simplest and most common form of business. It is not a separate legal entity, but an extension of yourself. As a sole proprietor, you own the business 100% and are responsible for all debts and obligations of the business. You may operate the business under your own name or do business under another name. For example, your business name could be Susie Smith Consulting or Susie Smith doing business as Dynamo Consulting.
A target market is the group of people or businesses that a company aims to sell its products and services to. The better a business understands its target market, the more it can tailor the marketing of its products and service to those customers to increase sales. This research can also help a business decide what types of products to carry or services to offer to be more attractive to those customers.
Variable costs are the expenses that increase and decrease based on the number of items produced or sold by your business. Examples of variable costs include sales commissions, raw materials, direct labor costs, and utilities. Businesses that increase their volumes often benefit from economies of scale by being able to purchase larger quantities of goods at a lower cost per item. This increases the profitability per item to grow net income or provides opportunities to reduce the sales price to attract more customers and undercut the competition.
The final word on business terminology
Knowing common business terms will help you run your business better. It enables more productive discussions with your management team, lenders, and investors about your business performance and financing needs. Plus, understanding these terms makes it easier to figure out how to make money at your new business and know what to focus on when evaluating the progress your business is making towards its goals.