Need-To-Know Business Terms: Defining the Basics
You recently took the leap and decided to start your own business, and now that you’re an entrepreneur, everyone thinks you have the lingo down. Sound familiar? As much as we love the small business community, there are some quirks that we could live without. One of them is this: the assumption that we all know what we’re doing. The reality is this: you can be a great business owner without knowing how to define “balance sheet” or what “LLC” stands for... but only for so long.
If you want to be able to speak professionally about your business, get funded, and succeed, you’ll need to know these concepts at some level. Luckily, you have predecessors to lean on. Here’s a short list of the terms you need to know about your startup and what they mean:
One of the first business terms you'll encounter is this one, defining how you form your company. Selecting an entity type for you business is critical because it determines two important foundations of your business:
- how you're taxed
- how much liability you vs. your company have
On the tax front, business entity types have different taxation rates, frequencies of filing, and ways you account for things (like how expenses are deducted). On the liability side, there are ranges of personal liability you incur personally, that you incur as the executive of the company, and that the company itself bears. You can personally be liable for everything or almost nothing, depending on entity structure. Here are a few of the most common in the U.S.:
- Sole-Proprietorship: You alone own the company and are solely responsible for its assets and liabilities. Basically, there is no difference between you and the company.
- Limited Liability Company (LLC): A formal organizational business structure that establishes a separate legal entity from its members. When you incorporate or form an LLC, you are generally protected from personally liability for business debts and most company actions.
- Corporation (C-Corp): These entities are owned by shareholders of stock issued by the company which is then run by a Board of Directors and Officers. Shareholders are provided limited liability coverage and aren't personally accountable for liabilities (such as debt). C-Corporations suffer from "double taxation," meaning income is taxed first at the corporate level, and then you as an employee of your own company are taxed again on an income paid to you by the corporation.
- S-Corp: Similar to C-Corps, but have restrictions on who shareholders can be and how many there can be. S-Corps "pass through" income to the shareholders who file on their own tax returns, so in a sense, S-Corps are exempted from federal and some state-level taxes at the corporate level, which alleviates the "double taxation" issue standard C-Corps have.
Zoning: In theory, all land has a specific purpose. Zoning describes a local government's authority over a specific piece of land, its use, and the buildings on it. Land's use can be designated as residential, agricultural, commercial, or mixed, among other specified purposes. Most importantly, zoning can determine what operations are prohibited on a certain piece of land, including where your home is located.
Bookkeeping & Accounting Terms
As owner, you will be responsible for understanding how money is flowing in and out of your business. Your bookkeeping and accounting form the formal process of how this is tracked and can help you understand how to optimize your business finances for better performance. Here are a few of the crucial terms you'll need to know to make your bookkeeping work for you:
- Balance Sheet: compares the things you own (assets) to things you owe (liabilities and shares of your company others own) at a specific moment in time. Compare a balance sheet against previous periods for an accurate picture of how the business is trending. You can also use this document to glean indicators of company health like the debt-to-equity ratio.
- Income Statement (profit & loss): reports how successfully a company is performing. Unlike the balance sheet, it depicts performance across a period versus on at a specific point. You can use the income statement to determine useful ratios like return on equity, return on assets, gross profit, operating profit and EBITDA (earnings before interest taxes and amortization)
- Cash Flow: shows how cash moves in and out through your company. It shows how viable your company is and how able you are to cover debts. Together with the balance sheet and income statement, this is one of the standard financial reports that you need to complete.
- Property Tax (a “personal property tax"): The word “personal” does not mean an individual owns the property. The law specifies this tax as “personal property for business use.” Equipment, office furniture, computers, etc. are considered “personal property.” Rules vary from state to state, but usually, you first pay taxes as sales taxes when you buy items, and later are pay an additional annual amount based on depreciated cost.
- Franchise Tax: Franchise taxes are not related to your profit but rather are fees you pay for the right to do business in certain states or cities. Do not get confused by the name, you will pay franchise tax even if your business is not a franchise.
- State Corporate Tax: Each state has its own tax laws which also depend on the type of the business you run. As corporations and LLCs have a separate tax liability from their owners, they are usually required to file separate tax returns for business.
- Federal Tax: The taxes you pay include your federal income tax, self-employment tax (if certain business types), employment tax (if you have employees) and sometimes excise taxes. You need to determine your fiscal year (which may be different from a calendar year) to know when to pay taxes.
- Local Tax: Each municipality can have its own rules about paying local taxes in addition to your state and federal ones. Typically these local registrations are for payroll purposes, but may involve gross receipts or other income taxes as well.
Running a business sometimes feels like learning a a new language, but you'll catch on. Luckily, we have a community that is willing to work together. What are the words you've learned since taking the leap, or what are the concepts that still confuse you? Post in the comments with your lessons learned.