5 key business terms you must know

Every business owner should know the basic business terms. It is important to understand how business works across all stages of the venture life cycle. Below is an easy cheat sheet to help you with the terms you should know to get your business up and running:

Business Plan

It is a tool used to detail the steps towards building your business and making it financially stable. A business plan should contain clear goals, in the financial, operational, and marketing aspects of your enterprise. It is best to make it as specific to your business as possible since it will be helping you in the long term.

Return on investment (ROI)

If you want to understand the financial prospects of your business, you must know about the ROI. Every entrepreneur spends their capital investment on boosting their goods or services to make a profit in the end. Simply put, the ROI is the profit divided by the total funds invested. The higher the ROI, the larger the profit.

Internal rate of return (IRR)

The decisions the entrepreneur makes must generate returns. The internal rate of return (IRR) is a calculation used to estimate the profitability of potential investments. Managers therefore use the IRR to rank multiple prospective projects on a relatively even basis. Assuming the costs of investment are equal among various projects, the project with the highest IRR would be considered the best and should be undertaken first.

Working capital

This is a measure of the company’s efficiency and its financial state. The working capital ratio reflects whether there are enough short-term assets to pay its debt. Working capital of 1.2 and 2.0 shows a good result, while a measure of less than 1.0 suggests there are liquidity issues in your business. When the ratio is under 2.0, it means that a company is not using its excess assets effectively in order to generate the maximum possible revenue.

Risk

Every business owner understands that risks are associated with the decisions made. There are three types of risks: premium, systematic and nonsystematic.

You must know that every company has its own risky projects. Hence, there is often a big dilemma of whether the risky project could bring a higher return or would not pay off. This type of risk is called premium.

A risk that cannot be avoided is called systematic. All companies in a single marketplace face those risks regularly. Such risks can be unique to separate markets.

The risk that is unique to your marketplace or company is known as nonsystematic. To avoid or ease the impact of a nonsystematic risk, you can use a diversification method to neutralize it.

When you face any type of risk, you should remember that low-risk decisions come with lower expected returns, while expected returns become higher with high-risk decisions.

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