The discussion whether entrepreneurs are made or born is never ending. Making a beginning of your own startup is quite risky, and for many entrepreneurs navigating their way in the highly competitive business scenario and securing the funding needed to survive is a major hurdle that is not easily overcome. The truth is, people don’t like to invest in startups and there is a limited amount of funding available for startup founders and innumerable new ventures born every day that keep competing for the funder’s mindshare. Investors simply do not open their wallets for every good idea that walks through their door. The ones that do secure funding are those that have demonstrated how that good idea will actually come to completion.
Most enterprises shut down because they don’t understand finances and the management of money. Experienced investors understand this fact that there are few legitimate overnight successes and that realistically they will be lucky to see a return on their investment in the next decade. Many new entrepreneurs, eager to prove the merits of their great idea, make the mistake of entering the discussion with an unrealistic value of their company. Not being realistic about the financial situation of their startup from the beginning shows a lack of understanding and frankly also lack of maturity. Understanding the money flow is very important for growth of business. Ideally, an investor is looking for a company with a lucid and scalable business model they can get behind and help grow.
Each entrepreneur has some strength which helps them in certain areas. Some are good at marketing, some at operations, some are naturally good sales persons, and some are good negotiators. But, the fact is there are a handful of entrepreneurs who are truly accounting & financial savvy. Most entrepreneurs fail when it comes to preparing financial statements and managing their books of accounts.
There are few basic financial terms which are important to understand and discussed with potential bankers and investors. It’s important to be aware of them and to understand how they affect a business.
- Assets: These are the economic resources a business has, including the finished products and partial finished products it has in inventory. The office furniture, the machinery, trademarks, and copyrights – anything tangible or intangible that is owns or controls to produce value and that is held by a company to produce positive economic value is an asset. Current assets include inventory, while fixed assets include such items as buildings and equipment.
- Liabilities: This includes any debt accumulated by a business in the course of starting, growing and maintaining its operations. It includes bank loans, credit card debts, and payments s owed to vendors and product manufacturers. Liabilities can be divided into two major types: current, which refers to immediate debts (e.g. money owed to suppliers), and long-term debt, which refers to liabilities (e.g. loans and accounts payable).
- Expenses: Business expenses are the costs the company incurs each month in order to operate: rent, utilities, legal costs, employee salaries, contractor pay, and marketing and advertising costs etc. To remain financially solid, businesses are often encouraged to keep expenses as low as possible.
- Cash Flow: Cash flow in business is the overall movement of funds through the business each month. It includes income and expenses. Businesses track general cash flow to determine long-term solvency. Cash is coming in from customers or clients who buy the company’s products or services. If customers don’t pay at time of purchase, that goes in accounts receivables. Cash goes out of business in the form of payments for expenses, like rent, electricity bills, monthly loan payments, salaries and wages, taxes etc.
- Bottom Line: This is the total amount a business has earned or lost at the end of the month. The bottom line is the last financial figure on a ledger. The term can also be used in the context of earning a business has made either increasing or decreasing. Bottom line is final total of an account or balance sheet.
- Financial Report: A financial report is a comprehensive account of a business in terms of transactions and expenses, created to give a business oversight of its financial matters. A financial report may be prepared for internal use or external sources, such as potential investors.
- Financial Statement: Similar to a financial report, a financial statement lists financial activities of a business. However, a financial statement is generally a more formal document, often issued by a lending institution. They are income statement which presents the revenues, expenses, and profits/losses generated during the reporting period, balance sheet, statement of cash flows and statement of retained earnings.
- Cash Flow Statement: A cash flow statement shows the money that entered and exited a business during a specific period of time. It generally covers four main categories: operating activities, investing activities, financing activities and supplemental information. The cash flow statement shows what changes will be projected in balance sheet accounts and how income will affect cash and cash equivalents; it breaks the analysis down to operating, investing and financing activities.
- Income Statement: It is also known as a “profit and loss statement,” an income statement shows the profitability of a business during a period of time. The income statement looks at a business’ revenues and expenses through all of its activities. The income statement is divided into two parts: operating and non-operating. The operating portion of the income statement discloses information about revenues and expenses that are a direct result of regular business operations. The non-operating section discloses revenue and expense information about activities that are not directly tied to a company’s regular operations.
- Balance Sheet: A balance sheet gives a snapshot of the company’s financial situation at a given moment. This includes the cash it has on hand, the payable, outstanding and owner(s) equity in the business.
- Profit and Loss: To remain financially healthy, a business must have a regular profit that exceeds its losses. Profits and losses are usually itemized on a profit and loss statement, also known as the income statement defined above.
- Capital: In business finance terms, the money a business has in its accounts, assets and investments is known as capital. In business, there are two major types of capital: debt and equity. Debt is money borrowed and to be paid by the business to financers or banks. Equity is owner’s investment in business.
- Accounts Receivable: This is the money that a company has a right to receive from its customers for providing them with goods and/or services. Usually the client is notified by invoice of the amount to be paid, if not paid, the debt is legally enforceable. On a business’ balance sheet, accounts receivable is often logged as an asset.
- Depreciation: Over time, a firm’s assets decrease in value due to the time that has passed since it was purchased. It is a reduction in the value of an asset over time, due in particular to wear and tear. For tax purposes, a business can recover the cost of that depreciation through deduction.
- Valuation: When a business seeks funding from investors, those investors want to know the overall worth of that business. This is accomplished through a valuation. Valuation is an estimate of the overall worth of the business. Valuation is the process of determining the economic value of a business or company. Business valuation can be used to determine the fair value of a business for a variety of reasons: this includes sale value, establishing partnership, and ownership. At times it helps in the entrepreneur in his divorce proceedings. Often, owners turn to professional business valuators for an objective estimate of the business value. Financial knowhow is important for both personal and professional life.