Financial Business Basics For Beginners

When it comes to navigating - and understanding - accounting business basics, what are the key terms you should know about in terms of working with numbers?

Many business owners are of the opinion that accounting is a fairly simple process, and don’t give the required tasks the attention that they deserve. Poor accounting and bookkeeping practices can adversely affect the financial health of any organisation, and can even put businesses on the path to insolvency if not properly addressed. 

However, like most things - knowledge is power, and so it’s important for brand owners to get a firm grasp on accounting business basics, and to ensure that the data and numbers available to them are able to be translated accordingly. After all, the information required to help you make better business decisions and proactively plan for the future is all within arm’s reach - but where to begin?

Eight Business Basics For Understanding Your Finances 

If you’re trying to get a better grasp on understanding your finances, then it’s important to know a few of the key terms used to describe cash flow health, profitability and liquidity - so consider the below glossary to be your crash course when it comes to accounting business basics. 

Debtor Days - The term used to describe the lapse of time between when you issue an invoice, verses when you actually get paid. The faster you can turn sales into cash, means the less cash (possibly from overdrafts) you need to finance your business activities. If you find that the average debtor days are increasing over time, it’s a sign you may need to re-evaluate your processes. The formula for calculating this is - debtors x days in period ÷ sales. 

Creditor Days - The opposite to debtor days, this is the time you need to pay your bills. To manage your cash flow, you need to strike a balance between keeping cash in your business as long as possible, but also settling your debts with suppliers in a timely manner. Increasing time lapses may be a sign of potential liquidity issues. The formula for calculating this is - creditors ÷ cost of goods sold x days in period. 

Working Capital Ratio - What we call working capital is the difference between your current assets, and your current liabilities. Businesses all need cash to “work” with in order to fund wages, rent, tax or more stock - basically, it’s how you pay for the day to day operations. The exact amount of working capital a business needs will vary, so the higher the working capital ratio, the better. The formula for calculating this is - current assets ÷ current liabilities.

Gross Profit Margin - A key indicator to your business or brand’s overall financial health, gross profit margins show whether the average markup on your product or services is enough to cover your direct expenses, and in turn make a profit. To calculate your business’s gross profit margin, you first need to calculate gross profit, and the formula for calculating this is sales revenue - costs of goods sold. To calculate the percentage, it is gross profit ÷ sales revenue x 100. 

Net Profit Margin - Otherwise known as the “bottom line”, net profit is the total amount earned - or lost - after paying all expenses. Of course, it is always a metric that you’ll always want to see positive, and the higher the better. To calculate your business’s net profit margin, you first need to calculate net profit, and the formula for calculating this is operating profit - taxes and interest. To calculate the percentage, it is net profit ÷ sales revenue x 100. 

Break Even Point - Knowing your break-even point is crucial if you hope to make informed business decisions, determine your pricing and assess your profitability. The process identifies the number of sales required in dollars or units before all business expenses are covered and profit begins. Sourcing cheaper materials and selling the same amount will lower your break even point. The formula for calculating this is - fixed costs ÷ gross profit margin. 

Quick Ratio / Acid Test - One of the best business basics to get familiar with is the quick ratio test, otherwise known as the acid test. It shows how quickly a brand can convert it’s assets into cash in order to pay off any current liabilities, but doesn’t include the stock components of current assets. You should aim for a ratio of 1:1 or higher, and the formula to conduct this test is calculated by current assets - stock ÷ current liabilities. 

Debt To Asset Ratio - As one of the key indicators of a brand’s financial leverage, if you have a high debt to asset ratio - you’re likely to be growing your business by taking on debt, rather than reinvesting business profits. Creditors and investors use this ratio to assess how risky (or safe) it is to loan you money - the higher the ratio, the more difficult finance will be to obtain. The formula for calculating this is - total liabilities ÷ total assets. 

Expanding On Business Basics With The Professionals

Whether you’re starting a business, purchasing an existing one, or even re-evaluating where your current one stands - all require some form of financial know-how if you hope to successfully navigate your legal requirements as well as hitting your business goals. 

However, if understanding the legalities that surround your business or finances isn’t your strong point, then it may be reassuring to know that you’re not alone. In fact, many businesses (big and small) enlist the services of an accountant in order to free up their time while knowing that their financial obligations are already taken care of by the professionals. 

Ultimately, the team at Muro believe that every business owner is an entrepreneur. However, accounting does not discriminate - finances break down barriers and are not territorial. If you would like to take a deeper look into your finances, please get in touch with us at Muro today to ensure that you’re on the right path for success.