8 How to Understand Business Finance
Table 1.1 Common terms in English and US English
English US English Other
Accounts
Budget
Creditors
Debtors
Depreciation
Dividend
Equity
Factoring
Fixed costs
Funds fl ow
Gearing
Gross margin
Indirect costs
Internal rate of
return (IRR)
Loans
Net profi t
Profi t
Profi t and loss account
Reserves
Return on sales
Sales
Shares
Stock
Variable cost
Financial statements
Business plan
Payables
Receivables
Amortization
Drawings
Owners’ funds
Cash discounting
Expenses
Cash fl ow statement
Leverage
Gross profi t
Sales, general and
administration (SG&A)
DCF yield
Debt
Net income
Earnings
Income statement
Retained earnings
Return on revenue
Revenue
Stock
Inventory
Fluctuating cost
Books
Operational plan
Accounts payable
Accounts receivable
Burden, overheads
Contribution
Income, top line,
invoice value
Cost of goods sold
(COGS)
2
The business cycle
Setting up a company
Businesses diff er to such a huge degree that each one is truly
unique, and yet they all go through one simple process in much
the same way. We will call it the business cycle. They produce and
deliver a product or service, they invoice the customer, they pay
their bills, they get paid by their customers, and they do the books.
We are going to set up an imaginary company to demonstrate this
process. The business is represented visually in Figure 2.1.
Let’s take a look at our business. First, we’re going to rent
an industrial unit. This can accommodate up to four
production units and the rent will be the same whether we have
one unit or four.
We’d like to have some cash in this business. In reality this
would be held in a bank account (or in your back pocket if you
were a market trader!) but we’ll have a cash box on our premises
to place this cash in. Do we want to have a lot or only a little
money in this cash box? Already we see a potential argument
brewing between departments, so let’s come back to this
question in a later chapter.
9
10 How to Understand Business Finance
90 DAYS 60 DAYS 30 DAYS
Figure 2.1 An imaginary business start-up
Next we’ll have an area representing the money owed to us by
customers. As you can see, we may have given our customers 30,
60 or 90 days to pay us and there is a box for each in our premises.
When we deliver goods we invoice our customers and depending
on the payment terms the money they pay should reach us in 30,
60 or 90 days. We can count that money but we can’t have it yet!
Month by month this money will move along, ever closer, until
eventually it will come into the cash box – and only then can we
spend it!
Underneath cash we have a ‘repay’ box. When anything hits
this area we have to pay it from cash. If we don’t have any cash we
must fi nd some or we are bankrupt. Never mind how much profi t
you are making, no cash means a bankrupt business.
On one side of this repay box we have the credit we can get
from suppliers after we have been trading for some time and
have established a track record. On the other side we have bank
loans – again, once we have a track record and provided we
11 The Business Cycle
meet the rules laid down by the banks we may be able to borrow
from them.
Lastly, down the right-hand side we have various costs
associated with running the business – rent, wages,
administration overheads etc.
What would you need to start a new business? At the
very minimum you would need:
An idea – a product or service. What is it you will be •
able to charge customers for (ie make a sale and
issue an invoice)?
Money – this is intentionally vague but you’ll need •
some sort of funding.
A plan – are you going to set up in your back room, •
rent an offi ce, DIY or hire staff etc? The better your
plan, the more likely your business is to survive and
succeed.
Let’s say our idea is to go into business installing white burglar
alarms. We’re going to buy in the white burglar alarm system and
we will charge people to install it in their homes.
Next we’ll need some money. Let’s represent this in grey
casino chips – each chip being worth £1,000. We’ll say that as
owners of this company we’ll put in £30,000 to start up the
business. This is represented by 30 grey casino chips which we
will place in cash, as shown in Figure 2.2.
12 How to Understand Business Finance
Figure 2.2 Cash for the business
The Moving Balance Sheet®
We’re now going to invest this £30,000 in the business. We will
want to keep track of where we spend this money; at least, our
accountant will. We’ll start a table recording what we have in the
business and where the money came from. Obviously these two
things should always balance (ie be the same), or else we could
just give up working and ‘cook the books’ whenever we want a bit
of cash to spend – while it lasts. This is shown in Table 2.1.
To install these white burglar alarms we are going to need
some equipment – a van, ladders, tools etc, and we’ll say this will
cost us £5,000. So we’ll buy this equipment and install it in our
industrial unit. To pay for this we take £5,000 from cash and place
it on the equipment. This is a visual representation of the value of
that asset, as shown in Figure 2.3.