Basic finance terms that every entrepreneur should fully understand.

They represent the core of understanding how

business development works across all stages in the life of a venture

1. Capitalization: This describes the way the company has funded its fixed assets. These assets include plant,
warehousing and other facilities; equipment and machinery; trucks, delivery vans and other vehicles; long-term
contracts; and telecommunications infrastructure. The "cap sheet" typically shows the long-term debt and the equity in
the firm. The equity will include preferred stock, common stock and any paid-in capital from outside investors, as well
as retained earnings from operations. The various ownership stakes in the company will be delineated, both by shares
owned and the relative percentage those represent of the company's total.

2. Depreciation: The fixed assets used in company operations have significant tax advantages for the company as well.
Depreciation refers to the incremental value of a brand-new asset that is lost each year due to normal use in the
company. Each year, equipment, buildings, machinery and vehicles lose some of their "newness" to technology
advances, as well to everyday wear and tear from usage. Over time, the company is allowed to deduct that "annual loss
in value" from its revenues (as if it is a cost), and this lowers the taxable income that must be reported when the
company files its annual tax returns. For example, a $100,000 write-off on some equipment is not money that goes out
of the company's cash flow, but it does the lower the taxable income by $100,000and that lowers the amount of tax
the company has to pay.

3. Amortization: This term describes how some purchases (or leases) can be posted to the company's books on a
periodic basis over time, rather than as a one-time expense. This allows the cost of an item to be deducted slowly over
time, rather than hitting the profit and loss statement all at once.

4. The modified accelerated cost recovery system (MACRS): This is the generally accepted method for determining
how much of a given asset's value can be written off each year. It's a schedule with pre-set categories of time for
various fixed assets the company acquires. The MACRS table shows what percentage of the asset's value can be
deducted as a tax write-off each year, over the useful life of the asset. One advantage is that MACRS assumes all assets
have no residual value (or salvage value) after the deductions are completed. This allows the entire cost of the asset to
be deducted over time, even though it might still be functioning well in the firm.

5. Marginal cost: Every additional product produced or service provided incurs an additional variable cost to the
company. This is the marginal cost, and it should be clearly known by the managers and tracked throughout each
month. This captures the incremental increase in labor and materials costs for one more unit produced or one more
service provided. The product's selling price should obviously then be above this variable cost of output.

6. Gross profit: The company generates a gross profit on every unit of output that sells to a customer. If it's a product,
the gross profit is the difference between the price at which it's sold, and the per-unit costs of labor and materials to
produce that unit. For example, if some electronic device costs the firm $20 in labor and materials, and it sells for $50,
the gross profit is $30 on each unit. If the company provides a service, the gross profit is the difference between the
billing rate to the customer (client) and the cost of the labor for that service (plus any supporting materials or equipment
used). For example, an engineering firm might charge $1,500 for some contract plans, and the firm's cost of producing
those is $900 of labor rate plus $100 in printing ($1,000 total). The gross profit is then $1,500 minus $1,000, or $500
on each contract completed.

7. Gross margin: The previously calculated gross profit is then also expressed as a percentage relative to the selling
price. This is the gross margin. For example, in the two prior examples, the product produced had a gross margin of 60
percent ($30 gross profit earned on a $50 selling price), and the service contract had a gross margin of 33 percent ($500
profit on a $1,500 contract).

8. Burn rate: Every company has a fixed amount of overhead costs that has to be paid every month, regardless of the
level of sales activity. This burn rate is how much cash the firm goes through in a typical month for things like rent or
mortgage for facilities; property taxes; all kinds of insurance (liability, workers compensation and property, for
example); salaries and payroll taxes for employees; the marketing budget; royalty fees or other license agreement fees
paid to partners; the printing or copying of mailings; telephones; IT infrastructure, including Internet connections and
web hosting; research and product development; and bookkeeping/accounting and legal fees. Break-even sales activity
is based on how much cash the company burns through every month.




9. Break-even point: This is the point in the annual output where the number of units sold, or number of services
provided, produces enough gross profit to cover all the fixed overhead costs of operations. For example, a $100 gross
profit per unit of output is first applied to the company's monthly burn rate of $100,000. Once 1,000 units have been
sold, the company has reached its break-even point, and every unit sold after that point brings in pure profit to the
company, as the fixed overhead has already been covered.

10. Volume: This refers to the quantity of units of output the company sells, or the number of times its services are
provided to customers. The company will first determine its break-even volume, and then how many units beyond that
will be the profit volume. Total volume is all units sold, or all services provided, for the entire year. Typically,
companies that want to do higher volume get there by lowering prices. Premium-priced products and services tend to
do lower volume, but they make that up with a larger profit margin.

Glossary: