You’re never too old, too wise, too knowledgeable or too successful to know every single thing. One thing that is seen commonly is that some of the founders skip the foundations. Now if your foundation is weak how can your building or whatever it is that you are building be strong? That’s almost impossible. The one percent of top players always go back to the basics. These seven business terms that every person should know can be your time, money, and confusion savers. Get to know the business terms right away.
1. EBITDA: What Your Business Really Makes
Stands for: Earnings Before Interest, Tax, Depreciation, and Amortization
What it means: It tells the money which your company actually makes from the operation, without any accounting tricks or financial engineering.
The Reason why it matters: An investor employs EBITDA to determine the value of a business. This measure alone reveals the true business performance by the removal of all other factors. On paper, two companies may have different profits, but EBITDA shows which one is generating more cash flow.
Example: Your company brought in $500,000 in revenue. After the expenses, you are left with $100,000 in profit. However, you paid $20,000 in interest, $15,000 in taxes, and $10,000 in depreciation. Your EBITDA stands at $145,000. This is the number that investors focus on.
When you’ll use it: Investor pitching, business selling or competitor benchmarking. This business term is an important one.
2. Product-Market Fit: The Deciding Point
What it means: A product that effectively solves a problem for which customers are willing to pay.
Importance: The majority of startups end in failure as a result of creating a product that no one desires(it’s sad but the truth is if your product is not giving the audience something new, it doesn’t stand a chance.) Product-market fit is an indication that you have landed at the intersection of customer need and your product.
Indicators:
- You don’t have to market heavily to attract customers
- Customers make purchases with minimal persuasion
- Word of mouth is the main factor that leads to expansion
- Retention rates continue to be high
Example: You create a project management tool. If customers are continuously cancelling their subscriptions, it means that you do not have product-market fit. And if there’s already a product out there that does the same thing your product does, the chances of customers switching is low as humans are creatures of habit. On the other hand, if they are referring your product to their friends and purchasing more expensive plans, then you have product-market fit.
When you’ll use this: The decision of whether to scale, pivot, or keep testing your idea.
3. Working Capital: Your Day-to-Day Lifeline
Formula: Subtract Current Liabilities from Current Assets (This is the first thing we learnt in our accounting class)
Explanation: This is the actual money that you can use to keep your business going daily. It is not sales or profit. It is the real money that you can use at this very moment.
The risk is: If you do not have enough working capital, you may go bankrupt though you may be profitable on paper. Unfortunately, bills don’t take breaks. Employees need to be paid. Suppliers require payment. If you don’t have enough working capital, your business is not going to run.
For instance: You have $50,000 in the bank and $20,000 in receivables (money owed to you). Thus, your current assets amount to $70,000. However, you owe $40,000 in bills this month. So, your working capital is only $30,000. That is your actual money to work with.
It might be helpful: Keeping a close eye on your cash flow, figuring out if you can afford to hire new employees, planning your inventory purchases. This decisions are important and might help you to manage your cash flow.
Main point: Even the best business idea is useless if you don’t have any working capital.
4. Assets: What Your Business Actually Owns
Meaning: These are the things that your business owns which either make money or have a certain value. These are the things that have monetary value and are very important for every single business.
Assets are any of the following:
- Money in the bank
- Capital goods and facilities
- Land and buildings
- Goods
- The value of your brand and intellectual property
- Patents and trademarks
Reason: Assets are what make your business viable and give it the ability to borrow money. Financial institutions loan money based on assets. Buyers pay based on assets. The better your assets are, the more stable your foundation will be.
Example: Assets of a coffee shop are the espresso machines, furniture, lease rights, and brand reputation. A software company’s assets mainly consist of intellectual property and code.
Time of use: A loan application, business sale, or net worth calculation.
5. Leveraged Buyout (LBO): Buying with Borrowed Money
What it means: The usage of borrowed money is the major part of the purchase of a company with the intention of selling it after a short time with a profit. The money that the company generates from its operations is used to pay back the loan.
Why it matters: LBOs are instruments that allow you to take over the businesses which are cash-intensive without risking heavily your own money. If the move is successful, you earn the profit. The loan is secured by the company’s assets.
Example: Let’s say you want to buy a company that is worth $10 million. You decide to put in $2 million of your own money and borrow $8 million. The company’s cash flow will be used to pay back the $8 million gradually. You only used $2 million to control a $10 million asset.
The risk: The risk is that, if the company is not able to generate sufficient cash, then you will be left with a debt that you will not be able to repay.
When you’ll use it: The buying of competitors, the rolling up of small businesses in your industry, or private equity deals.
6. Amortization: Spreading Invisible Costs
Meaning: Essentially, it is the spread of the cost of intangible assets to the period during which the assets are used.
Main difference from depreciation: Depreciation is related to the physical things (machines, buildings) while Amortization is related to non-material ones.
Amortization examples:
- Patents
- Trademarks
- Software licenses
- Brand value
- Goodwill from acquisitions
Significance of the concept: The assets that are not visible, but are still there, are the ones that provide real value to your business. Amortization is the way to account for those assets over time instead of recording a huge expense in one go.
Example: You purchase a patent for $100,000 which has a lifespan of 10 years. The amortization instead of showing the $100,000 as an expense for this year, shows $10,000 per year for 10 years.
When you will use it: Financial statements, tax planning, understanding your balance sheet.
7. Liabilities: What You Owe
Explanation: These are a total of things that the business has to do of the whole business besides the things it owns. The reverse of assets.
Common liabilities:
- Employees wages and salaries
- Business loans
- Mortgage or rent payments
- Taxes owed
- Supplier invoices
- Credit card debt
Reason to be concerned: If you subtract liabilities from assets, the result will be net worth. To be in control, you have to know both sides of the equation.
Example: Business of yours is holding $200,000 in assets while liabilities amount to $150,000. So your real net worth is $50,000. Being aware of this keeps you from making decisions as if you were overly confident.
When you’ll use it: You will need it for making financial decisions always. Business health can only be properly evaluated if you know what you owe.
Wrapping it Up
No entrepreneur is too good for the fundamentals. It’s important to master the basics first to become a master in the market. Don’t skip out on these business terms that everyone should know, they are important and if you start using them today, your future self will thank you.
