Wouldn't it be nice if you could predict your business's financial success? You might be able to if you keep your eye on these seven all-important financial terms.
As a small-business owner, your days are packed with an endless number of tasks that keep your business on track. When you do finally flop down exhausted on the couch after work, it’s probably not to pour over your financial statements. But that's a big mistake.
By tracking inventory on a regular basis, you can spot problems early enough to avoid the negative effects of excess inventory, which include storage costs, reduced profits, and potential waste.
While it might not be your favorite post-work activity, it’s important to keep a close eye on the critical numbers that can help you predict the success of your business.
“Without tracking a few key financial figures, you don't know how much is being spent and what can be trimmed, and as a result, you can’t lower overhead costs or expenses,” says Jessie Seaman, a licensed tax professional and a senior associate staff attorney at Tax Defense Network. “There's always time to increase net profit, so every month, you should input your transactions and use the resulting figures to make smart business decisions moving forward.”
To help ensure that your business stays in the black, take the time to familiarize yourself with these seven key financial terms.
Financial Terms That You Should Know
Understanding these financial terms can give you the information that you need to make solid business decisions. It can help you to see how much you're making and spending, allowing you to make accurate projections and giving you the data that you need to grow your business. Here's a look at seven financial literacy terms that you should know today.
1. Cash Flow
Operating cash flow offers a bird’s-eye view of the economic state of your business. This figure is computed by subtracting your operating expenses from the money your company generates during normal business activities. It includes depreciation to your net income and adjusts for working capital like receivables and inventory. When your operating cash inflow exceeds your cash outflow, this is a sign that you’re operating in the black. If the reverse is true, it’s time to take a closer look at your income and expenses.
“Sufficient cash flow in your business checking accounts, especially payroll accounts, is critical,” says tax lawyer Daniel Petri, a tax analyst with the Tax Defense Network. “Small-business owners should always make sure they have the necessary cash flow to meet all monthly business expenses.”
2. Net Income
Closely related to cash flow is your net income, which is also known as your net earnings and net profit. This figure constitutes the result of subtracting all your expenses from your income. It's not adjusted for items like depreciation. Like cash flow, your net profit is a good indicator of whether you're earning or losing money.
3. Profit and Loss
This figure is found on what's commonly known as your P&L statement, which is a snapshot of your company’s income (sales and revenue) minus expenses during a specific period of time, which is generally quarterly, every six months or yearly. Knowing your company’s profit and loss over time allows you to project earnings and make realistic plans for the future, both short term and long term.
Given that generating sales is the reason most entrepreneurs operate small businesses, this figure is a given on the critical numbers list. Keeping a close eye on sales is important, as a dip could be a warning sign of trouble. In the same respect, it’s important to pay attention when sales are up. Determining why business is good at the time your company's on an upward trajectory is easier than trying to figure it out later. Reacting quickly to an increase in sales also allows you to determine what you need to keep doing to sustain that growth.
5. Price Point
“Small-business owners should know exactly how much it will cost them to purchase their goods and then what they'll need to sell those goods or services in order to make a profit,” says Petri, who notes that this is an especially critical number for restaurants and other retailers. “When you determine price point," he adds, "make sure to take into account all overhead expenses, such as utilities, payroll and sales tax.”
6. Gross Margin
Also known as your gross profit – and related to price point – this figure reflects how much money remains after the actual cost of your merchandise is subtracted from the selling price. If this figure is low and not sufficient to cover your operating costs, such as salaries, rent, marketing, and utilities, then you're likely not charging enough for your products and services.
7. Total Inventory
Monitor your inventory numbers on a weekly basis to ensure that the amount of inventory isn’t gradually increasing, as this could be a sign of sales trouble. By tracking inventory on a regular basis, you can spot problems early enough to avoid the negative effects of excess inventory, which include storage costs, reduced profits, and potential waste.
Understanding your critical financial numbers may not be as exciting as making a big sale, but keeping an eye on these must-know figures will give you precious peace of mind – and a glimpse of what the future holds for your business.
A version of this article was originally published on June 9, 2014.
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