Tech startups are on the rise. Between 25 and 40 startups in Silicon Valley alone are valued at over $1 billion, with that number possibly growing to over 100 in 2014. As startups continue to grow and prosper — as evidenced by the November 7, 2013 Twitter, Inc. IPO, which brought $25-30 billion in value to the company — it is important that tech entrepreneurs understand the importance of certain accounting terms.
Here are ten basic terms that every startup owner should be familiar with: (1) assets; (2) liabilities; (3) double-entry accounting; (4) fixed costs; (5) variable costs; (6) owner’s equity; (7) accounts payable; (8) accounts receivable; (9) sales transaction; and, (10) return on equity.
An asset refers to an item that has a value and is owned by a company. Assets can be something tangible (cash, computer equipment, vehicles, etc.) or intangible (business name trademark, goodwill, etc.). Assets are an important way to assess the value of a business.
Where assets are items of value owned by a business, a liability is something that a business owes. Liabilities may be short-term in nature, such as an invoice payable in 30 days, or long-term, as in the case of a mortgage note payable in 30 years. When liabilities are subtracted from the assets of a business, the resulting amount is referred to as the business’s net worth.
Double-entry accounting is a system of accounting that shows how money moves between different accounts of the business. A business that purchases a piece of equipment using cash would account for the movement of the purchase by deducting monies from cash and adding to the expense account from where the purchase will be made.
A business’s fixed costs refer to expenses (costs) that remain constant. An example of a business’s fixed cost would be the costs associated with the lease for its office space. Generally, office rent is set at a rate that is predetermined in the lease for a fixed period of time, such as 12 months, 36 months, 5 years, etc.
Variable costs refer to expenses that are not regularly occurring or set at a regular rate. A tech company that provides bandwidth services to its customers may see changes in its costs based on customer Internet usage. Higher usage will result in a higher cost to a business while lower bandwidth usage will result in a lower expense charge.
To determine owner’s equity (also referred to as net worth), simply subtract liabilities from assets, as explained in the definition for liabilities above.
Amounts owed by the business that have yet to be paid for goods or services ordered and or used are recorded on the company’s accounting books and records as accounts payable. These amounts are listed by date in order to determine how long they have been due (aged), which can be a measure of creditworthiness.
Receivables are amounts or sums of a business that are owed to the business. An example would be all customer invoices of the startup sent to customers for services rendered that have yet to be paid back to the company.
Sales transactions refer to the exchange of goods and services by a business to a customer in exchange for something of value, most commonly currency. Sales transactions create sales revenue for a business and eventually result in income (after certain expenses are accounted for).
Return on Equity (ROE)
This measure of a company’s profitability looks at the amount of income after expenses (net income) as a percentage of owner’s equity. The higher the ROE, the more profitable the business is.
This article was written by Richard Craft, an MBA student who hopes to help you and your business. He recommends taking a look at the accounting jobs with moneyjobs.com if you’re interested in a career in accounting or if you know anyone who is. Check out their website today!