Small Business Accounting Terminology

Here is some terminology that you should become familiar with as it pertains to your business:

  1. Revenue break even point. This is the dollar revenue amount whereby fixed expenses are covered by revenue contribution. It is found by subtracting variable expenses from revenue. The contribution margin in dollars is divided into revenue to get the contribution margin percentage. This percentage is divided into fixed expenses.
  2. Business capitalization. This is found on the “right side” of the balance sheet. Trade creditors, the Canada Revenue Agency and long term creditors provide “external capital.” Shareholder equity and shareholder loans are sources of “internal capital” – along with annual profits. The ratio of external capital over internal capital (I call this your business “beta”) is a measure of risk. The higher the beta the higher the risk.
  3. Gross Profit Margin (GPM). The is found by dividing gross  profit (in dollars) into revenue. Revenue less direct costs (material and labour) gives us the cost of goods sold. Revenue less cost of goods sold gives us the gross profit. The percentage GPM tells management how effectively, efficiently and economically the business converts direct inputs into dollars and whether the gross profit is sufficient to cover general overhead.
  4. Fixed Cash Burn Rate. This is the dollar total of all fixed cash expenses the business incurs in a month without depositing one dollar of customer receivables. It includes: commercial rent (including HST), net payroll and employer remittances, monthly insurance (PAC) charges, equipment or other leases, equipment rental, loans and fixed bank charges. This rate should be compared to the average monthly cash deposits to determine the percent coverage required from these fixed expenses. If your business has a FCBR of 80% or more – be careful. A downturn in business could be disastrous.
  5. Working Capital. This is a standard measure of liquidity. It is found by deducting current liabilities from current assets. The general feeling is that the ratio should be at least 2:1. To look at this a different way, find your working capital in dollars and deduct the bank account cash balance. If the figure is still positive, this is the amount of financing for  trade receivables or inventory your business outstanding. If it is a large number you will experience cash flow problems despite the size of the ratio.
  6. Cash Profit. This is found on the Statement of Changes in Cash Resources Statement. You start with the accrual accounting profit or loss figure from the Income Statement. You add back amortization and other non cash items and the period-over-period change in receivables, inventory, prepaids and payables/accruals. The net figure is the cash profit. It is used to cover fixed debt repayment charges, repayment of shareholder loans or to pay a dividend. Your business may be profitable but does it spin cash? This figure will tell you.

 

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