rel="nofollow" href="#litres_trial_promo">7.3 Measure short-term solvency and liquidity
7.4 Measure long-term solvency and stability
7.6 Estimate the value of a business
Financial awareness is fundamental to business success
Many business people, professionals and senior executives who may be experts in their field are sometimes less confident in finance. Quite often this is unfounded and can easily be overcome. In the business world the ability to understand finance and communicate financially is essential.
To date, I’ve spent almost two decades working in finance. I’ve spent a large proportion of this time teaching others. Early on, I found that learning finance was akin to learning a language. One of my own finance teachers told me, “It’s not the numbers, it’s the English you’ll find hard!” – and my own experience proves that this is certainly true. Accountants will often use several names for the same thing. Where possible I’ve tried to give alternative explanations when introducing a financial term. The Jargon Buster at the back of the book should also help you get to grips with some key financial terminology.
In this book I’ve picked 50 secrets that will help you get to grips with finance basics. I’ve divided the secrets into seven chapters which cover seven crucial areas every business person should understand.
Introducing business finance. Business owners, managers and employees need to have a basic level of financial awareness to help a business succeed.
Accounting fundamentals. Make sure you know basic financial terminology and concepts. Be familiar with the main financial statements produced by a business.
Making profit. Profit is the raison d’être for most businesses. Knowing how to make and increase profit is one of the key ingredients for business success.
Managing cash. “Profit is sanity but cash is reality.” Without cash a business cannot survive for long. Effective cash management will help a business to endure.
Budgeting. Many businessess invest considerable time in budgeting but few do it successfully. Some practical tips can improve the process.
Evaluating business opportunities. Businesses should use established techniques to help decide whether or not to commit time, resources and money on investment opportunities.
Measuring business performance. A successful business can be judged by the size of its market value. Its performance can be measured by using financial ratios.
From students who are interested in business finance to chief executives who want to know more, this book can help you get to grips with finance basics. You’ll even find it interesting and it can help you with your future business activities.
Financial knowledge is not just for accountants – it’s for everyone!
Owners, managers and employees need to be aware of the financial consequences of running their business. In this chapter I’ll explain the different types of business entities. I will show you where a business gets its money from and what it does with it. You’ll appreciate the need to record, analyse and summarize business transactions. I’ll also explain the essential difference between financial accountants and management accountants.
1.1 Know the different business entities
A useful starting point to understanding business finance is to appreciate the different ways of trading. There are three main categories: sole traders, partnerships and limited companies. Each offers advantages and disadvantages in relation to legal issues, taxation and the personal liability of its owners.
1 Sole traders. A sole trader or proprietorship is a business with 1 one owner, who has unlimited personal liability. If the business becomes insolvent, the proprietor is personally liable for any unpaid debts. Examples can include shopkeepers, tradesmen (e.g. electricians), hairdressers and florists.
2 Partnerships. A partnership is a business with multiple owners, who share profits or losses. The partners can share unlimited personal liability or can take limited liability status. Examples tend to include doctors, dentists, lawyers and accountants.
“A friendship founded on business is better than a business founded on friendship” John D. Rockefeller, industrialist
3 Limited companies. A limited company is a business incorporated by law. Its owners are ‘shareholders’ who have the benefit of limited liability. If the business becomes insolvent the shareholders are only liable for the amount they invested in the company. Limited liability is a key advantage of turning a business into a limited company and can help to attract potential investors. In practice, however, banks may require personal guarantees from shareholders of small owner-managed businesses for loans or overdrafts. There is also an increased administrative and financial burden, in comparison to sole traders.
A limited company can be ‘private’ or ‘public’. Most companies, especially small ones, are private and are owned by a small number of shareholders. In the UK, private limited company names end with the suffix ‘Limited’ or ‘Ltd’. The directors of a private limited company are also likely to be the majority shareholders.
Public companies are usually much larger than private compa-companies. Their shares can be sold and purchased on a public stock exchange. In the UK public company names end with the suffix ‘Public Limited Company’ – or ‘PLC’.
This book will be useful to all entities and in particular limited companies which experience the most regulation.
Limited liability is a key advantage for limited companies.
1.2 Find out how a business gets money
The majority of businesses need money to get started. The ability to raise finance is essential to the initial and ongoing success of a business. A lack of finance is one of the main ways that businesses fail.
Imagine you about to start a new business that requires $1 million initial investment. Let’s say this money is needed for premises, a motor vehicle, computer equipment and goods to sell. If you don’t have $1 million, where can you get the money from?
Most entrepreneurs will initially invest their own money when starting a new business. This is known as ‘share capital’ and for limited companies the owners are called ‘shareholders’. ‘Share