7 Financial Terms that Your Business Should Know
The first step in gaining that strong knowledge of small business finance is to understand the language, and, when it comes to finance, that’s no easy task. Fortunately for you, we’ve compiled a list of seven financial terms that your business should know.
1. Loan term
Definition: The loan term is the period of time that your loan agreement is valid. After the end of a loan’s “term,” you’ll back or refinance the loan.
What you need to know: The term of your loan dictates short and long-term budgeting decisions for your business. Not only that, it’s important to time things well when it comes to financing. That’s what makes the “loan term” one of the most vital measures to consider when evaluating loans.
2. Debt Consolidation
Definition: The process of combining multiple debts into a single debt in the form of a loan.
What you need to know: If you’re paying off multiple debt items with high interest rates, you might consider debt consolidation. For most business owners, the idea with debt consolidation is to use one, low-interest loan to pay off multiple debts with high interest rates. With debt consolidation, you still have a loan to pay off, but ideally, you’ll reduce your interest payments.
Definition: The asset, or item of value, that the lender uses to secure their loan to you. The lender may take possession of this asset should you fail to pay your loan back.
What you need to know: Not every loan requires collateral, but most large loans do. That’s because banks use collateral to protect their downside risk. For example, if you default on your home mortgage, at least they have a house they can liquidate. Because collateral gives lenders some protection from downside risk, if a lender doesn’t require collateral, you’ll have to compensate them for their risk in other ways.
Definition: In the context of small business, a liability is any financial obligation that your company has. According to Investopedia, this includes loans, mortgages, deferred revenue, and accrued expenses.
What you need to know: Liabilities will appear on the right side of your balance sheet. The type and amount of your liabilities can tell you whether your business is overextended or not. However, what’s considered an appropriate level of liabilities will change drastically depending on your industry and the age of your business.
5. Fixed Asset
Definition: A fixed asset is an item that holds value for your business and is unlikely to be quickly converted to cash.
What you need to know: As Accounting Tools points out, a fixed asset doesn’t actually have to be “fixed” to be considered a fixed asset. Rather, fixed assets are reported under the property, plant, and equipment category in your balance sheet. That means a fixed asset is anything you use for long-term productive use in your business.
6. Cash Flow
Definition: The liquid funds, cash or cash-equivalents, that are transferred in and out of your business.
What you need to know: Cash flow is one of the most important things you can use to evaluate the short-term viability of your business. It’s the money you have on hand to pay your bills. Without healthy cash flow, your business will likely fail, regardless of how much money you’ve generated on paper.
7. Balance Sheet
Definition: A financial statement that lists everything your business owes (liabilities) on the right side and everything your business owns (assets) on the left side.
What you need to know: Lenders and analysts will use the balance sheet on your business to evaluate the way your company is structured. Investors may also use it to calculate their return on money that they’ve invested in your company. The balance sheet is limited in that it only gives you a snapshot of the business at a particular point in time.
You should look at similar businesses’ balance sheets, as well as past balance sheets of your own to gain greater context for your evaluation.
This list is by no means exhaustive. However, by knowing just these seven terms, you’re better equipped to evaluate business loans as well as the health and capital structure of your company. There’s much more to learn, but if you familiarize yourself with these seven terms, you’ll have taken a great first step to the financial education that will help you run your business.
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