Know Your Numbers: 5 Essential Components of Business Finance that Women Entrepreneurs Need to Know

Women-led entrepreneurship has the potential to be the driving force to steer the African continent towards economic and social development goals through job creation and poverty alleviation. However, a lack of financial literacy is one of the key challenges affecting the business growth of women entrepreneurs.

The most essential skill that a business owner can bring to their company is understanding, tracking, and using certain numbers. 

Financial literacy plays an important role because it provides the financial tools needed to make informed decisions, through the accurate understanding of business performance and company success.

Turnover, Gross Profit, COGS, EBITDA, and countless other terms have everything to do with how one views the profitability of a business. But what do they all mean and why are they so important? 

In this two-part series on Business and Finance, we focus on the most crucial financial terms that are often misrepresented. These financial elements are crucial to ensure business success and sustainability.

Revenue

The simple way to view revenue is: all of the money that comes into the business from various sources. This could include product sales or services rendered. Revenue is what keeps you in business. 

• Operating Revenue: The money that a company generates from selling goods or services is your operating revenue. Some companies inaccurately use the terms sales and revenue interchangeably. However, while sales are revenue, all revenue doesn't necessarily derive from sales. There are supplementary sources of revenue which are often one-time events, including investment windfalls, money awarded through litigation, interest, royalties, the occasional event, and so on.

• Turnover: Most often, turnover is used to understand how quickly a company collects cash from accounts receivable or how fast the company sells its inventory. Revenue determines the growth and the sustainability of the company, while turnover provides insight into production levels and inventory management.

Expenses

Business expenses are ordinary and necessary costs a business incurs in order for it to operate. It is an amount of money spent in order to carry out one's work.

• Cost of Goods Sold (COGS) - COGS are the direct costs incurred to produce goods and services, such as material cost and labor, and are directly proportional to revenue.

  Expenses and COGS are not synonymous. Expenses include all your other costs of running the business, such as marketing, PR, and technology. Business expenses are the ordinary and necessary costs a business incurs during regular operations. 

Profit

Profit is calculated as total revenue minus total expenses. It is important to understand both gross profit and net profit, which are not the same:

• Gross profit - Known as the first level of profitability, gross profit is the money a business makes after subtracting all the costs that are related to manufacturing and selling its products or services. Gross profit = sales - COGS

• Net Profit - Net profit is a company's total earnings after subtracting ALL expenses, including depreciation and taxes. Net profit is commonly referred to as a company's “bottom line” and is a true indicator of a company's profitability. 

Cash Flow

Also sometimes referred to as the bank balance, this is the cash that moves in and out of a business. Cash inflows usually arise from one of three activities – operating, investing or financing. Cash outflows result from expenses, investments in assets, and payments to creditors or owners. In a healthy business, there is constant cash flowing in (from sales) and out (to pay rent, staff, etc.). Not having enough cash or mismanagement of cash is the number one reason that businesses fail. This is why cash is often referred to as “king.”

• Burn rate - This refers to the rate at which a company spends its supply of cash over time. If companies burn cash too fast, they run the risk of running out of money and going out of business. (It is usually represented as cash spent per month.)

If a company doesn’t burn enough cash, it might not be investing in its future and may fall behind the competition. The cash flow statement includes information related to a company’s burn rate. 

• Cash Runway - This is a calculation of how long your cash is going to last based on your current burn rate, provided that you don’t raise additional funds. While you build the business, you are probably spending more than you’re making and the goal is to reduce your cash burn rate to zero and become cash-flow positive before you run out of money. Remember: cash runway = how much money you have in the bank / burn rate. 

EBITDA

EBITDA is an acronym for Earnings Before Interest, Taxation, Depreciation and Amortization. In other words, your turnover less COGS, overheads and other expenses. EBITDA is the most common way to report Net Profit and a measure of the company's overall financial performance. When a company is not making a profit, investors can turn to EBITDA to evaluate a company.

• Depreciation - Depreciation is the term given to the decline in a tangible asset’s value, either due to market conditions or other factors like wear and tear.

• Amortization - Amortization is the process of spreading the repayment of a loan, or the cost of an intangible asset, over a specific timeframe; usually a set number of months or years, and it will often incur interest payments, set at the discretion of the lender.

• EBIT - Known as a subset of EBITDA these are Earnings Before Interest and Taxation. The key difference between EBIT and EBITDA is that EBIT deducts the cost of depreciation and amortization from net profit, whereas EBITDA does not...EBIT therefore includes some non-cash expenses, whereas EBITDA includes only cash expenses.

Financial literacy is an essential and intangible resource that is critical for growth, success, and sustained competitive advantage. 

By mastering these basic finance terms, you not only gain a more holistic view of your business, but also can better analyze the performance of specific teams and the business as a whole.

Stay tuned for Part 2 where we will explore the most common mistakes startups make with their finances and how they can prevent them.