Top Finance Terms Every Founder Should Know

A company’s balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. Balance sheets can be used with other important financial statements to conduct fundamental analysis or calculate financial ratios.

Assets = liabilities + equity.

The left side is what you own, the right side shows what you owe. Which makes your assets equal to your liabilities and equity.

How Balance Sheets Work

Watch Video > Preparing a Balance Sheet

An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.

Assets are reported on a company's balance sheet. They're classified as current, fixed, financial, and intangible. They are bought or created to increase a firm's value or benefit the firm's operations.

Understanding Assets

Liabilities are things that a company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services.

Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.

How Liabilities Work

A Chart of Accounts (COA) is an index of all the financial accounts in the general ledger of a company. In short, it is an organizational tool that provides a digestible breakdown of all the financial transactions that a company conducted during a specific accounting period, broken down into subcategories.

How Charts of Accounts Works

Watch Video > How to Organize your Chart of Accounts

Equity, typically referred to as shareholders' equity (or owners' equity for privately held companies), represents the amount of money that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debt was paid off in the case of liquidation. In the case of acquisition, it is the value of company sales minus any liabilities owed by the company not transferred with the sale.

Shareholders’ equity = total assets − total liabilities

How Equity Financing Works

A company’s income statement primarily focuses on the company’s revenue and expenses (revenue, expenses, gains, and losses) during a particular period. 

The income statement reports income through a particular time period, usually a quarter or a year, and its heading indicates the duration. 

Understanding an Income Statement

Watch Video > A Guide to Income Statements

Bookkeeping is the process of tracking and recording a business’s financial transactions. These business activities are recorded based on the company’s accounting principles and supporting documentation.

Examples of these documents include: Bills, Receipts, Invoices, Purchase orders

There are two different accounting methods to keep track of things: Accrual Basis and Cash Basis.

Benefits of Bookkeeping

With Accrual Basis accounting, revenue is accounted for when it is earned. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future. In other words, money is accounted for before it's received. Expenses for goods and services are recorded before any cash is paid out for them.

With Cash Basis accounting, revenue is reported on the income statement only when cash is received. Expenses are recorded only when cash is paid out. The cash method is typically used by small businesses and for personal finances.

Revenue is the money generated from normal business operations, calculated as the average sales price times the number of units sold. It is the top line (or gross income) figure from which costs are subtracted to determine net income. Revenue is also known as sales on the income statement.

Understanding Revenue

An expense is the cost of operations that a company incurs to generate revenue. As the popular saying goes, “it costs money to make money.”

Common expenses include payments to suppliers, employee wages, factory leases, and equipment depreciation

Understanding Expenses

Gross income is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross income will appear on a company's income statement and can be calculated by subtracting the cost of goods sold (COGS) from revenue (sales).

Understanding Gross Income

Net Income is calculated as sales minus cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses. It is a useful number for investors to assess how much revenue exceeds the expenses of an organization. This number appears on a company's income statement and is also an indicator of a company's profitability.

Understanding Net Income

A net loss is when total expenses (including taxes, fees, interest, and depreciation) exceed the income or revenue produced for a given period of time.

Understanding Net Loss

Cashflow is the net amount of cash and cash equivalents being transferred in and out of a company. Cash received represents inflows, while money spent represents outflows.

Understanding Cashflow

Watch Video > How to Prepare & Analyze Cash Flow Statements

Profit margin represents what percentage of sales has turned into profits. The percentage figure indicates how many cents of profit the business has generated for each dollar of sale. If a business reports that it achieved a 35% profit margin during the last quarter, it means that it had a net income of $0.35 for each dollar of sales generated.

Understanding Profit Margin

Return on Investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost.

To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment.

A Variable Cost is a corporate expense that changes in proportion to how much a company produces or sells. Variable costs increase or decrease depending on a company's production or sales volume—they rise as production increases and fall as production decreases.

How Variable Cost Works

Fixed Cost refers to a cost that does not change with an increase or decrease in the number of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent of any specific business activities. This means fixed costs are generally indirect, in that they don't apply to a company's production of any goods or services. 

How Fixed Cost Works

Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. 

Understanding Liquidity

Accounts Payable refers to a company's short-term obligations owed to its creditors or suppliers, which have not yet been paid. Payables appear on a company's balance sheet as a current liability.

Understanding Accounts Payable

Accounts Receivable is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivable are listed on the balance sheet as a current asset. It is any amount of money owed by customers for purchases made on credit.

Understanding Accounts Receivable

Capital is a broad term that can describe anything that confers value or benefit to its owners, such as a factory and its machinery, intellectual property like patents, or the financial assets of a business or an individual. While money itself may be construed as capital, capital is more often associated with cash that is being put to work for productive or investment purposes.

Understanding Capital

Working Capital, also known as net working capital (NWC), is the difference between a company’s current assets—such as cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods—and its current liabilities, such as accounts payable and debts. 

It's a commonly used measurement to gauge the short-term health of an organization.

Understanding Working Capital

The term Human Capital refers to the economic value of a worker's experience and skills. Human capital includes assets like education, training, intelligence, skills, health, and other things employers value such as loyalty and punctuality. As such, it is an intangible asset or quality that isn't (and can't be) listed on a company's balance sheet.

Understanding Human Capital

The burn rate is typically used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. It is a measure of negative cash flow.

The burn rate is usually quoted in terms of cash spent per month. 

Example: If a company has $1 million in the bank, and it spends $100,000 a month, its burn rate would be $100,000.

Understanding Burn Rate

Runway is the amount of time a company has before it runs out of money. If a company has $1 million in the bank, and its burn rate is $100,000, the company’s runway would be 10 months.