Starting a new business is a daunting task, no matter what size enterprise you want to create. Whether you’re setting up a small boutique, baking pies out of your home, or dreaming of something larger, you want to establish your new venture correctly from the beginning. You can never have too much information or be too familiar with the basics of sound business practice, so I’ve created this section as a resource covering some of the nuts and bolts of business. This collection of definitions, references, and other resources is by no means comprehensive or definitive; it is simply my curated compilation intended to equip you with the basics of aerodynamic propulsion needed to get your business off the ground. I hope you find it useful and refer to it frequently.
Definition of Terms
Sole Proprietorship
A sole proprietorship is the simplest business model and, as its name implies, refers to a business owned and managed by only one person. The owner, or sole proprietor, is in direct control of all parts of the business and is also responsible for all the finances of the business, including any debt. Legally, in a sole proprietorship there is no difference between the business and the person. While the owner receives all the benefits of the business (income, profits, assets, as well as tax write-offs), the owner is also financially liable for any losses. For example, if the business owes any money, the owner’s personal finances can be used to cover that debt.
Although the owner and the business are basically one entity, the business can have a different name. It often varies by state or region, but it’s traditionally been known as “Doing Business As” or DBA. This filing allows you to use a fictitious name for your business that is different from your personal name and allows you to operate in all functions under this name, including getting a bank account for your business, an essential part of managing it successfully and keeping verifiable records.
Partnership
A partnership is a business that is owned by more than one person, with the division of assets and liabilities determined in the partnership agreement. The duties of each partner also have to be spelled out in the partnership agreement, as well as the financial responsibilities, so that both or all partners operate and perform under the same guidelines and consistent contractual understanding.
I’m a big believer in partnerships. Two or more people working together allow the business to leverage the strengths and skills of each partner to create a total greater than the sum. It’s not just a cliché—two heads are better than one! With more knowledge, more experience, and more talent, the chances of success will always be exponentially greater.
Corporation
A corporation operates as a legal entity separate from the owners or the group of officers, often known collectively as a board of directors. The corporation has all the legal rights of an individual and can enter into contracts and other legal agreements, obtain credit, hire employees, and sue or be sued by another individual or corporate entity.
There are several types of corporation, with the most common being a C corporation, an S corporation, and an LLC (limited liability company). Each type of corporation has specific contextual advantages as well as limitations, and each carries distinct tax implications. In order to determine which corporate structure is best for you, do your homework and then consult a professional accountant, business attorney, or both. Don’t encumber your business with more administrative layers than you need to operate effectively and efficiently.
Assets
Assets include all cash, cash equivalents (including accounts receivable), and property owned by a business. Products in inventory, office furniture, supplies such as computers, cell phones, and tablets are all assets, although over time they will not retain the value of what you paid for them. But all have value and can be liquidated at any point. These are considered tangible assets, items you can put your hands on, sell if needed, and immediately infuse cash into a business.
Most businesses have other, more intangible assets as well, including trademarks, patents, copyrights, intellectual properties. Over a period of sustained success, even the name of a business may become equitable and add financial value to a business and its worth.
Liabilities
The opposite of assets, liabilities refer to items in the negative column of the balance sheet and represent any debt for which the business is liable, which in turn reduces the company’s net worth. Liabilities often include credit cards, business loans, and outstanding bills that have to be paid to suppliers or other vendors. All taxes that have to be paid and any money owed to investors must also be considered liabilities.
Not all liabilities are current, meaning that some bills are due immediately (for example, the rent for your office space is due in full each month) as contrasted with long-term debt, such as a loan that is repaid over time.
Cash Flow
Cash flow refers to the amount of money flowing in and out of the business on a regular, often monthly or quarterly, basis. It’s basically determined by subtracting immediate liabilities from liquid assets in order to calculate the remaining balance of available cash. Positive cash flow means that the money coming in is enough to cover expenses, debt, and reinvestment (in terms of marketing, promotion, or expansion) and also to set money aside and save to provide a buffer against future financial issues that may arise.
This point bears repeating: every business needs to have money in savings for the same reason that you keep money in a personal savings account. Unexpected expenses come up—maybe a machine breaks or your monthly revenues were less than projected. Or something positive may happen—a catering business may receive a larger than normal order and need additional money from savings to cover the additional costs to fill the order. Whatever the reason, every business must have some money set aside. Negative cash flow, of course, means just the opposite: the business is not bringing in enough money to cover expenses. Cash flow must be closely monitored because too many months of negative cash flow will deplete all your assets and resources, forcing you to terminate your present business operations.
Accounts Receivable
Accounts receivable refers to the amount of money your business is owed by your customers and clients. Many businesses do not have accounts receivables because the customers pay for the products they receive at the point of purchase. Many service businesses, however, such as day care centers, home health care agencies, and janitorial businesses bill monthly. In these situations, clients are typically given “net 30” terms, meaning they have thirty days to make the payment for the product or service received. This is money in the pipeline. Whenever paid, this cash flow into your business contributes to its overall health, both short-term and annual.
Bottom Line
I suspect we all know what this is! The bottom line is the amount of money the business has earned or lost during a specific amount of time, usually a month, quarter, or year. Most businesses analyze this on a monthly basis rather than week to week because many things can change in the short term of seven days. A thirty-day view, however, offers a fairly accurate measurement of how your business is performing month to month. This perspective usually provides a picture of trends such as which months are strongest, when revenues are trending up or trending down, and when expenses are trending up or trending down. These patterns and cycles help you understand whether your bottom line is strong or needs strengthening.
Financial Reports
The financial reports of the business give you a comprehensive account of everything that is going on within the business financially. There are several reports that you (or your accountant) should create and compile for your business regularly. These reports are usually required documents when seeking financing or presenting proposals to potential investors.
Even if you’re building this business yourself with your own financing, it makes sense to do these reports regularly to have an understanding of the health of your business. After all, while you may not have any outside investors, you have invested. You are the stockholder and therefore should have an idea of how your investment is growing.
The three financial reports most crucial to monitoring the financial side of your business are:
1. BALANCE SHEET
The balance sheet is a financial statement indicating the bottom line, or big picture, of a business. It tells you what a business is worth (what the company owns and what it owes) over a specific period (monthly, quarterly, annually) and provides a snapshot of the business for that time frame. The balance sheet adds up the company’s assets, its liabilities, and the capital of the business or the owner’s equity.
This is called a balance sheet because the report has two columns and the two sides should balance each other. One side lists all the assets of the business and the other side lists the liabilities and the owner’s equity.
Assets = Liabilities + Owner’s Equity
2. PROFIT AND LOSS STATEMENT
This financial statement (also referred to as a P&L or Income Statement) takes a picture of projected sales and income compared to expenses (for the same period) to determine the net profit during that time. The formula for the Profit and Loss Statement typically looks like this:
Gross Profit – Total Operating Expenses = Net Profit
While most of the time Profit and Loss Statements are summarized quarterly or annually, some businesses may calculate P&Ls for a shorter duration. With certain businesses, projecting a P&L often makes sense for determining the viability of a certain event, product, or client. This may be the case for an event planner or a caterer. For example, an event planner trying to determine the profitability of a particular event would compare the gross profit, the amount of money the event planner will earn for putting together the event, with total operating expenses, the cost of putting on the event. This has to include all costs the event planner will incur, such as the rental of the venue (if the planner is covering that), the employees’ salaries for the additional servers who will be used for the event, all costs for the food and drink, the costs for any music or other entertainment, the cost of travel, and any other expenses that the event planner has to cover, and so on. The difference between the gross profit and the total operating expenses determines the net profit (or net loss).
For an event planner, this P&L can determine if a particular job is profitable enough to accept. Doing a P&L over a longer period of time and then comparing the current P&L with previous ones will highlight any changes in your business and could show potential areas of concern. For example, you may see that your income or gross profit is growing but your expenses are increasing at an even greater rate or percentage. When you see these kinds of red flags, you can analyze the steps you can take.
3. CASH FLOW STATEMENT
This statement highlights how much money is coming into the business and how much money is going out of the business. What is coming in includes all sales: cash, credit cards, accounts receivable. What is going out includes all credit and debt expenses, salaries, taxes, as well as loans or any other expenses that must be paid. This statement will help you answer this most important of questions: can I stay in business at this ratio? In other words, can you sustain flight at this altitude knowing the amount of fuel required to fly that high? Cash flow statements show the liquidity of the company.