Glossary
Assets
These are things of value that the company owns such as inventory, buildings, vehicles, bank accounts, etc. This also includes intangible items like patents, copyrights, websites and other digital assets. These are listed on the Balance Sheet and are often incorrect due to poor bookkeeping. Common mistakes are due to inaccurate inventory management, not accounting for fleet vehicles properly, excluding digital assets, and not maintaining accurate Accounts Receivables (A/R).
Cash Flow
This refers to the management of cash into the organization (Cash Inflow) from customer payments, loans, investors, etc. and cash out of the organization (Cash Outflow) from payroll, bill payments, debt repayment, etc. This is often confused with Profit. However, a business can be profitable and still have cash flow problems due to challenges collecting customer payments (Aging A/R), the timing of bill due dates (Terms), and large debt payments.
COGS (Cost of Goods Sold), COS (Cost of Service) and COS (Cost of Sales)
These are costs directly related to producing the product or service the company sells. COGS is the term used for products, Cost of Service (COS) is used for companies providing a service, and Cost of Sales (COS) is a term used for either or both. This is part of the Income Statement (aka P&L) and is subtracted from Revenue to derive Gross Profit. A common bookkeeping mistake is confusing these costs with SG&A (aka Operating Expenses or Overhead).
Debt Management
This refers to building a strategy around how a business wants to use debt. This could be as simple as creating a plan to expedite paying off debt the organization has incurred. It could also include using debt to finance larger expenditures such as acquiring more physical assets or staffing the business to scale. All debt instruments such as loans, lines of credit (LOC), credit cards, etc. should be listed as Liabilities on the Balance Sheet. Many businesses have bookkeeping errors in this section such as debt not listed, having the incorrect balance, or showing a balance when it has already been paid off. The first step in Debt Management is to ensure the Balance Sheet is accurate.
KPI’s (Key Performance Indicators)
These are business metrics that leadership believes must meet a certain criteria for the business to be successful. These metrics represent drivers, such as New Customers Onboarded per Quarter, to financial statement line items, such as Revenue, as they are indicators of success. A good financial strategy must include KPI’s to monitor whether the business remains on track to meet future goals. KPI’s are often part of a scorecard that is scored weekly, monthly or quarterly.
Leveraged
This is when a business has used debt to help fund its operations. Cash Flow issues and underperforming Revenue expectations often lead to the necessity to inject debt in the business ensuring there are no issues with the flow of business. If this is a consistent occurrence, it is a red flag as highly leveraged operations are not sustainable long-term. Though these organizations will likely have plenty of cash in the bank, it can mislead one to believe the business is successful. A strategy to increase sales and reduce expenses is necessary to get these businesses back on track.
Liquidity
This refers to a company’s ability to meet its short-term (within 1 year) obligations. Assets that are Long-Term Assets, such as money tied up in property, are excluded. This includes Current Assets such as Cash, Accounts Receivable (A.R), and sometimes Inventory (depending on what financial ratio is used). The sum of these is compared to Short-Term Liabilities such as credit card balances, loans due within 1 year, and Accounts Payable (A/P) to derive a multiple. A ratio of less than 1.0 is not good. Depending on the industry, a liquidity ratio such as the Quick Ratio (Current Assets excluding Inventory / Current Liabilities) should be between 2.0-3.0.
Net Profit
This is the amount of money left over after subtracting all expenses including COGS, Operating Expenses, Interest, Taxes, Depreciation and Amortization from Revenue. Though Profit is a general term which can refer to various profit levels on the P&L such as Gross Profit (uses COGS only), Contribution (uses Variable Expenses only), EBITDA (excludes Interest, Taxes, Depreciation and Amortization), and EBIT (excludes Interest and Taxes), Net Profit includes ALL expenses.
Operating Profit
This profit measure includes the amount of money left over after all COGS and Operating Expenses have been subtracted from Revenue. Sometimes, this is synonymous with EBITDA or EBIT. This is a commonly used profit measure since it explains the actual profitability of the operation of the business before factoring in taxes, the cost of debt, and the impact of changes of certain Asset items.
Profit Margin
This is expressed as a percentage and represents the portion of Revenue a business is able to keep as Profit. All profit measures can be expressed as margin. For example, Gross Margin is the % of Revenue left after subtracting COGS (Gross Profit / Revenue) and Net Profit Margin is the % of Revenue left after subtracting all expenses (Net Profit / Revenue). Profit should always be expressed in “$” and Margin should always be expressed in “%”.
Pro Forma
As it relates to business finance, a pro forma is a high-level (not a detailed Income Statement) projected profitability statement based on assumptions. These are not actual financials. Instead, it is a projection based on future changes. For example, it may show expected profitability if certain changes were made to a product. Finance will often partner with Marketing to show the financial impact of product changes they are considering. They do this by creating a pro forma statement. It is a good idea for businesses to build and review pro formas before making final decisions regarding changes to their products or services.
Projections
This term is often used to describe a forward-looking financial statement, such as an Income Statement for future months or years. Projections are commonly used by startup businesses, as they are required by investors. They are typically associated with new business ideas or growth opportunities. Forecast is another term used for forward-looking financial statements, but this term refers to future financial performance of ongoing business often extrapolated from historical actual financial performance.