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Financial Literacy for Entrepreneurs: Know the Basics

Being an entrepreneur doesn’t mean you need a finance degree. In fact, successful business owners come from a wide range of backgrounds and sport many different skill sets.

While most companies eventually hire CFOs and have fully staffed accounting departments, those are luxuries that most small businesses can’t afford early on. So, among the many hats you’ll have to wear as an entrepreneur is that of chief financial officer – tackling budgeting, financial statements, and other critical money tasks.  This means you’ll you need to have some basic financial literacy. The following are 10 key terms and concepts that every entrepreneur should understand.

10 Financial Literacy Basics for Entrepreneurs

1. Revenue

Revenue (or “gross sales” or “the top line”) is simply all the money your business brings in. Simple as that.

Revenue is the very first item on the profit-and-loss (P&L) sheet, and it doesn’t factor in any expenses, taxes or other accounting metrics.

In general, the idea is, the more revenue, the better. But revenue isn’t everything. You have to consider several expenses, such as …

2. Cost of Goods Sold

Cost of goods sold (COGS) are costs you incur directly from selling products – this includes things such as labor, raw materials, shipping and any items you need to sell a product.

Annual COGS is calculated by taking your inventory value at the start of the year, then adding purchases made during that year, then subtracting your inventory value at the end of the year.

3. Operating Expenses

Operating expenses, often called “opex,” are the regular costs a business incurs to keep its day-to-day operations running. This covers everything from rent and utilities to employee salaries, marketing and office supplies. Essentially, it’s the money spent to maintain and grow the business outside of direct production costs.

4. Profits

Profits (or “earnings” or “net income” or “the bottom line”) is what you have left over from your revenues after factoring in a host of other considerations, including research and development costs and taxes. Specifically, it’s calculated as revenue minus COGS minus expenses.

5. Profit Margin

Profit margin is the percentage of revenue a company retains as profit after accounting for all costs. It’s a key metric for assessing a business’s financial health and efficiency. There are three main types of profit margin you should be aware of:

  • Gross profit margin: This is money left after subtracting the cost of making or buying whatever it is you sell.
  • Operating profit margin: This margin takes into account expenses such as salaries, rent and utilities.
  • Net profit margin: This takes into account what’s left after all expenses and other accounting lines are accounted for.

6. Depreciation

Depreciation is an accounting method used to spread out the cost of a tangible asset (like machinery or a building) over its so-called useful life. It reflects the fact that the asset loses value over time due to wear, tear or becoming obsolete. Depreciation helps businesses allocate expenses accurately.

7. Amortization

Amortization is similar but applies to intangible assets (like patents or copyrights). It’s a way to allocate the cost of such assets over their estimated useful lifespan.

8. Return on Investment

Return on investment (ROI) is the profitability of an investment relative to its cost. It’s calculated as a percentage by dividing the net gain or profit from the investment by the initial investment cost, and the higher the ROI, the more profitable investment. (Example: If you invest $1,000 in a project and it generates a profit of $200, your ROI is 20% ($200 profit / $1,000 investment). ROI helps investors and businesses alike evaluate the potential returns of various investments, which helps them determine how to allocate resources and make investment decisions.

9. Customer Acquisition Cost

Customer acquisition cost (CAC) is the total expense a business incurs to acquire a new customer. This includes marketing and sales costs like advertising, salaries and commissions. To calculate CAC, divide the total acquisition costs by the number of new customers gained in a specific period. CAC is crucial for evaluating the effectiveness and efficiency of marketing strategies.

10. Customer Lifetime Value

Customer lifetime value (CLV) estimates the total revenue a business can expect to earn from a customer throughout their entire relationship. It factors in purchases, repeat business and referrals. To calculate CLV, subtract the customer acquisition cost (CAC) from the total revenue generated from that customer. CLV helps businesses understand the long-term value of acquiring and retaining customers.

Is Your Small Business Prepared for Economic Ups and Downs?

Like we said before: You don’t have to have a finance degree to be an entrepreneur – you just need to have some basic financial literacy. But there will be times where some important financial tasks are above your level of understanding, and that’s OK.

That’s where we come in.

If you have questions about your company’s finances, it’s time to talk to the accounting experts at McManamon & Co. We work closely with you to create financial statements, maintain records and provide expert guidance on financial accounting matters.

Reach out and find out what we can do for you and your business! Just call 440.892.8900 or contact us online.

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