FINANCIAL TERMS EVERY ENTREPRENEUR SHOULD KNOW

Know Your Numbers

Most entrepreneurs know there are costs involved in running their business, but a lot do not know the difference between certain financial terms involved in their business. To help with that, here are a few terms that every entrepreneur should know.

Gross Revenue vs. Net Income

Some entrepreneurs consider their gross income – what they receive from customers and clients – their profit. Unfortunately, we must account for costs of running the business before we can calculate profit. Your gross revenue is simply the amount of money you are paid by clients and customers.

Your net income is the money that is left after paying your expenses. Net income tells a much more accurate story than gross revenue. This is the profit you are making off your product.

Variable Costs vs. Fixed Costs

When it comes to a business, not all costs are the same. Perhaps the most important way to distinguish them is between variable costs and fixed costs.

Variable costs will go up or down based on how much product or service you sell. These costs are directly tied to earning revenue. This will include items such as sales commissions, supplies and raw materials, and independent contractors. If the expense can be tied to a specific sale, it is likely a variable cost.

Fixed costs, on the other hand, will remain the same no matter how much product you sell. These are called operational costs, and they will include things like rent, salaries, insurance, advertising and marketing, and any other business cost that is not tied to an individual sale.

Usually, variable costs are easier to cut than fixed costs. Fixed costs tend to be locked into long term contracts, such as rent contracts and employment contracts.

Equity vs. Debt

Debt generally comes at a cost of interest owed to the lender. When you take out a loan with the bank, you are accruing debt.

Equity is ownership in your company. Unlike debt, there is no interest expense involved with equity, however you are giving up a piece of your business.

For the most part, debt is more dangerous than equity because of the cost of interest. But giving up too much equity can leave you with very little say in your own business. As Steve Jobs found out the hard way, even the founder of the company can be fired once he no longer owns most it.