Business Terms Every Small Business Owner Should Know

Key takeaways

• Learn the core finance terms, from accounts payable to working capital, so you can read your own numbers with confidence.
• Use plain definitions to speak clearly with vendors, lenders, and your accountant.
• Recognize how your business structure and tax IDs like an EIN or ITIN shape how you register and file.
• Keep records for at least three years, and longer for employment taxes, to stay ready for the IRS.

Accounting

Accounting involves the systematic recording and reporting of business financial transactions. It’s often complicated and you may want to consult or hire a professional to help out with this process.

Accounts payable (AP)

Accounts payable (AP) is the money you owe to creditors, vendors, and suppliers for goods or services they’ve already provided.

Accounts receivable (AR)

Any payment you expect to receive for goods or services you supplied is considered accounts receivable (AR). Even though AR refers to money that hasn’t been paid yet, it’s listed on the balance sheet as a current asset. Plus, any amount of money owed by customers for purchases made on credit is considered AR.

Assets

Your business’s total financial holdings, or in layman’s terms, everything your business owns is called assets. The two main types of assets are tangible and intangible. Tangible assets are physical or quantifiable objects with a clear financial value. Intangible assets are not physical objects you can touch or count. While they have monetary value, which affects the company’s worth, it is often difficult to quantify.

You can also split assets into two groups:

• Current assets: things you expect to turn into cash within 12 months, like cash, inventory, and raw materials.
• Non-current assets: things that won’t convert to cash within a year, like real estate, vehicles, office furniture, and stocks and bonds.

Balance sheet

A balance sheet summarizes the state of your business’s financial status and is often a useful tool for investors or stakeholders. It includes a list of assets like cash on hand and inventory, liabilities like expenses, taxes payable, and owners’ or stockholders’ equity.

Cash flow

Cash flow represents the balance of money flowing in and out of your business at a given time. It represents the amount of available cash you have on hand that can be used to cover your expenses and liabilities, including AP, salaries and taxes, to name a few. While AR is money owed to you, it’s not considered cash flow until you receive the payment.

Cost of goods sold (COGS)

All costs involved in the product or service your business is selling are called cost of goods sold, or COGS. If you run a landscaping business and are building a fence for your customers, the cost of materials like wood, paint, nails, their delivery, and the cost of labor would all be summed up and called COGS. As a business owner, you would need to charge a sum on top of that in order to make a profit.

Employer identification number (EIN)

EIN or employer identification number is a number used to identify business entities for tax purposes. The nine-digit number is also known as the Federal Tax Identification Number.

Expenses

While this term seems trivial, it’s really important to know what you can consider a business expense. A business expense is a cost that businesses incur when running their operations. Equipment, inventory, and rent are all examples of business expenses—money you spend to keep your doors open.

Expenses are deducted from revenue to arrive at profits. Businesses are allowed to deduct certain expenses from taxes to help alleviate the tax burden and bulk up profits. Not sure what’s considered a business expense? That’s where your accountant can help.

Gross profit

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing services. Gross profit is an indicator of a company’s financial health and success. However, even if the gross profit is positive, that doesn’t mean the company is profitable.

Invoice

An invoice is a document sent by a seller to a customer to provide documentation of a sale that has yet to be paid for and is typically due at a later date. According to U.S. law, a valid invoice needs to adhere to a specific format, unlike a bill, which is more flexible.

ITIN (individual taxpayer identification number)

An individual taxpayer identification number (ITIN) is a tax processing number issued by the IRS.

Liabilities

Your business’s financial obligations or unpaid debts are liabilities. Vendor bills, loans, and payroll are all liabilities. Like assets, you’ll have to define liabilities as either current or long-term. Current liabilities include any debt a company intends to clear within the next 12 months. Non-current liabilities are debt that will not be covered within a year, like long-term loans.

Net terms

Net terms are deferred payment terms offered to customers who are seeking extended periods of time to pay for their goods and services. Suppliers that extend net terms to their customers typically give them between 30 and 120 days to make full payment.

Net profit

Net profit is your sales revenue minus all costs. Those costs include:

• Cost of goods sold
• Operating and administrative expenses
• Depreciation and interest
• Taxes and other expenses

Point of sale (POS)

A point of sale (POS) is the device or system you use to accept payments. A cash register is a simple example, but most businesses now use electronic POS terminals that take credit and debit card transactions.

Receipt

For most business expenses, you should keep receipts and other records for three years after filing taxes, since that is the general period of limitations. Keep some records longer, though. The IRS recommends keeping employment tax records for at least four years, and keeping records for seven years if you file a claim for a loss from worthless securities or a bad debt deduction.

Reconciliation

Account reconciliation means comparing the numbers in an account with other financial records to verify the balances match. So basically, making sure your books match your bank account.

Differences that are detected when reconciling the accounts are called discrepancies.

Reconciling the books is important not just for the sake of those of you who don’t like a messy back office. It also keeps your business on track with its finances, as well as with different regulatory requirements.

Revenue

Revenue is the total income your business earns from selling products or services in a given period, before any expenses are subtracted. In other words, it’s the money you get from selling your service or product.

Sole proprietorship

A sole proprietorship—also referred to as a sole trader or a proprietorship—is an unincorporated business that has just one owner who pays personal income tax on profits earned from the business.

It’s the easiest type of business to establish because it has fewer government regulations. Most small businesses start as sole proprietorships and either stay that way or expand and transition to a limited liability entity or corporation.

Working capital

Working capital is the amount of money your business needs to operate day to day. When starting a new business, it can be tricky to calculate your working capital as there are a lot of unexpected expenses. But the more time you’re in business, the easier it gets.

To see how much cash you have for day-to-day operations, subtract your current liabilities from your current assets. The result is your working capital.

Break-even point

Your break-even point is the moment when your total revenue equals your total costs. You’re not making a profit yet, but you’re no longer running at a loss. Knowing this number helps you set prices and sales goals with confidence.

Business structures beyond sole proprietorship

A sole proprietorship isn’t your only option. As your business grows, you may want a structure that offers more protection or flexibility.

• Partnership: Two or more people share ownership, profits, and responsibilities.
• Limited liability company (LLC): Keeps your personal assets separate from business debts, with flexible tax options.
• Corporation: A separate legal entity that can raise money from investors and offers the most liability protection.

Your choice affects your taxes, paperwork, and personal liability, so it’s worth talking through with an advisor.

Know your basics

That was probably a lot of terms to take in. Down the line, however, you’ll know these by heart. It’s a good idea to have them handy and if they come up in a conversation, just come back here and take a peek.

Ready to put these terms to work? Sign up for Melio to manage your bill pay and invoicing in one place.

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