Knowing financial terminology important
Every business owner should be familiar with a few common financial terms. We toss around business language like some people toss around acronyms (BTW, we at the SBDC try to avoid such behavior). Some are daily business terms. Others are used in only special situations (like borrowing money) but all should be clear in the business owner’s overall management style.
Capital: This is the equity of a business, including your investments and retained earnings. This is seen on the balance sheet and is often called “owner’s equity.”
Retained earnings: This is also a balance sheet item and is increased (or decreased) by the profit (or loss) of operations that is transferred to the balance sheet at the end of your accounting period.
Equity: This is the difference between the fair market value of something and any balance owing. If you own your house valued at $100,000 and owe $60,000 on the mortgage, your equity is $40,000
Assets: these are the things you own that are worth money. They may include land, savings, investments, accounts receivable, prepaid accounts, inventory and equipment.
Liabilities: These are the things you owe. They may include mortgages, loans (to all lenders including shareholders), installment loans, undeposited payroll taxes and accounts payable.
Working capital: This is the difference between your current assets and liabilities (those that can be converted or paid within one year). This shows your available “liquid” money and your ability to pay current debts. Also, in a loan proposal, working capital is the amount of “cash” you borrow to pay future expenses. Keep in mind that you cannot just ask for cash — it must be tagged to specific expenses.
Liquid: These are assets that can be realistically turned into cash within one year.
Collateral: This is assets pledged to secure a loan. If a loan is not repaid, the assets would be sold and the proceeds used to retire your obligation. Rarely will a bank consider current market value as the collateral value as they would not expect the need to foreclose on a business failure for some time thus the asset would be worth considerably less at a later time.
Discount: This is when assets are valued lower than their market value to make sure they can be sold quickly (see collateral).
Depreciation: Except for land, assets lose their value. This loss in value is amortized.
Amortized: This is when you spread the value of an asset over time. For example, if a machine is bought for $10,000 and used for 5 years, straight-line depreciation would decrease the value of that asset by $2,000 per year.
Marcia Bagnall is Director of the Chemeketa Small Business Development Center and instructor of Small Business Management Program. The Small-Business Adviser column is produced by the center and appears each Sunday. Questions can be submitted to SBDC@chemeketa.edu. Visit the SBDC at 626 High Street NE. in downtown Salem or call (503) 399-5088.