8 Vital financial terms all freelance designers should know

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If you graduated from art school, a trade school, or even with a liberal arts degree, you know that they don’t teach you how to go into business for yourself.

Suddenly, besides designing and dealing with clients, we’re thrust into this world of accounting, bookkeeping, and finances. After all, a business that doesn’t make money is just a hobby, and it doesn’t put food on the table.

Unless you can afford an accountant, you learn about the financial side of freelancing on your own…and sometimes, through the school of hard knocks.

So I’ve put together a list of “beyond the basics” financial terms (with examples!) all freelance designers should know to help you get on the right track to a profitable business…and understand your bookkeeping software.

Profit and Loss Statement

Lists the income and expenses of a business over a period of time. Also known as an income statement.

In layman’s terms: A snapshot of a company’s financial results over a period of time.

A P&L Statement (as it’s often referred to) is key to your success because you can see if and how you’ve been profitable over the past month, quarter, or year and how that compares to the previous time period. You can also see where your biggest expenses are and look for ways to reduce those costs.

Revenue

Income a company receives from its normal business activities.

In layman’s terms: Positive cash flow from business income.

Example: Income from working with clients and passive income (PS here’s how to generate passive income as a designer).

The difference between revenue and the cost of making a product, promotional products or providing a service, before deducting overhead, payroll, taxation, and interest payments.

In layman’s terms: The amount of money you made prior to paying for general business expenses not directly tied to providing a service.

Example: Your revenue is $10,000, but it directly costs you $200 to provide those services. Your gross profit is $9,800.

Net Profit/Net Income

A measure of the profitability of a venture after accounting for all costs.

In layman’s terms: Your business’ take-home pay after all the bills and expenses have been paid, commonly referred to as “the bottom line.”

Example: Your gross profit is $20,000. Your expenses (advertising, utilities, office supplies, etc.) cost $2,000, so your net profit or net income is $18,000.

PS – Follow this one simple principle to avoid wasting that hard-earned net profit.

Cost of Goods Sold (or cogs)

The total cost of manufacturing and delivering a product or service. This includes raw materials, shipping costs, merchant account fees, and sales/referral commissions.

In layman’s terms: What it directly cost you to provide a service to your client.

A great rule of thumb for determining if a particular expense is a cost of goods sold is to ask yourself, “Would I have incurred this expense if I did not make this sale?”

Example: As part of your business identity package, you pay for the printing of business cards up front. You make $1,000 for the design, but it costs you $50 to print the business cards. The $50 is considered a cost of goods sold, because you wouldn’t have paid that $50 if you didn’t create the business cards for the client.

(Cost of goods sold typically refers to a product-based business but is widely used in the financial world for service-based businesses as well. Sometimes the term “cost of revenue” is used for service-based businesses because it makes more sense.)

Merchant Account (and Merchant Account Fees)

A type of bank account that allows businesses to accept payments, usually associated with fees to participate in their program.

In layman’s terms: Fees associated with using an account to receive money.

Example: Paypal, Square, or any credit card processing company. When you invoice someone in Paypal, Paypal takes an arguably small portion of your client’s payment in compensation for providing the service they do. This fee is considered a merchant account fee, which is considered a cost of goods sold (because you wouldn’t pay the fee if you hadn’t sold the service).

Asset

Any item of positive economic value owned by a business.

In layman’s terms: Items that you own that could be converted to cash.

Examples: A computer, office chair, printer, cash.

Note: Fixed assets are long-term assets not expected to be converted to cash in the current or upcoming fiscal year, such as furniture and business equipment. Most of our assets as freelancers are fixed assets, but if you wrote a book, for example, and had 500 copies on hand, those would be considered assets as well.

Depreciation

The decrease in the value of assets.

In layman’s terms: Over time, things become worth less (cars, computers, etc.). Depreciation is the measure of how much less.

Example: You buy a new computer at the beginning of the year for $800. Over the year, it loses value as newer, faster computers are released and you put wear and tear on yours. By the end of the year, it might only be worth $600, so it depreciated $200 over the course of the year.

Do you have any to add to the list?

While I could go on and on, this list is a great start to understanding your freelance finances.

What terms baffle you (or baffled you until you figured them out)? Was this list helpful? Share your thoughts with us by leaving a comment on this post!

About April Greer

April is a go-to freelance designer with a rare combination of creative expertise and technical savvy. She is available for subcontracting and speaking engagements – visit Greer Genius for more information.

Comments

  1. I have to say I was “lucky” in a sense, because I was an accountant before I found my true calling of designer. And, “unlucky” in a sense, because I was an accountant before I found my true calling. ;-) Now I LOVE my job!

    • Tamian,

      Understanding accounting is a big feather in your freelancing cap – and good for you for having the courage to switch gears and follow your passion!

      Thanks for sharing!

  2. I found this article to be extremely helpful and insightful. As a designer who is in business we have to wear many many hats. This is indeed a good guide to help others when it come to the accounting side of things. One tool I use that I find extremely helpful is Out Right it’s an account software I use to track expenses and income. It pulls data from my bank accounts and credit cards. I can print and view reports and more… It’s free!!

  3. Not necessarily a financial term, but I would add “Opportunity Cost” to the list. I travel and attend several industry-related conferences a year speaking. While I categorize the time away as ‘Marketing’ (meeting potential new clients, networking, etc.), it is a cost in time to my business. When I’m there I’m not working. That’s time. So I have to look at the value of the event in terms of what I can get out of it for potential growth and weigh that against not going and work existing projects or market through other channels.

  4. How about the difference between ‘margin’ and ‘mark-up’? Knowing this has changed the way I charge and my business’s profitability.

  5. Alfred Ingram says:

    If you’re not expensing the entire cost of your computer, you’re paying money to Uncle Sam you aren’t required to. Get the small business tax pamphlet and you’ll find that your government is trying to encourage you to start and stay in business.

  6. I do think this article is interesting but it doesn’t really help me to solve the “problems”.
    It would be great to have some advises and tips (like the outright software) in regard of what and how to organize our freelance life during the year without getting crazy when it comes to taxes declaration. I know, I should track all my expensive and hours every day but I have not time… does this sound familiar to someone?!
    This is the period I don’t know where to start from counting!

    Any tips to simplify my life?
    Thanks

    L!SA :)

  7. Regina Wright says:

    Hello! This article is absolutely wonderful – especially since I am solely right-brained. I’m wondering if the way I file income taxes is the best for me. I do not have employees and simply file my graphic design income and expenses on the same 1040 used for my family. The problem is when my tax preparer enters expenses for printing, stock photography and other payments, my refund plummets significantly. In the graphic design business, is it a good practice to enter these items as expenses or as cost of goods sold? I’m clueless.

    • Regina,

      I’m not an accountant, so I can’t promise my advice is correct, but I will attempt to answer your question.

      A great rule of thumb for determining if a particular expense is a cost of goods sold is to ask yourself, “Would I have incurred this expense if I did not make this sale?”

      So if you wouldn’t have bought stock photography or incurred printing expenses if you weren’t working for your client, then it should be a cost of goods sold.

      Now, I don’t know how that will affect your refund; however, that’s how you generally should approach your bookkeeping (unless you have a special case and your tax preparer/accountant says otherwise).

      Good luck!

  8. Regina Wright says:

    Thanks for your help April! Great insight. I’m also renaming and rebranding. Any ideas anyone? I love creative names like Etsy and Gilt that would let me be 100% creative since they did not previously exist.

  9. Thank you April…… I loved this article. I have learned a lot this information will help me to take control of my business finances. Thank you

  10. Hi April, I’m so glad I came across your article as it’s highlighted some problems for me which I hope you can help with. I’m struggling to know whether to put some things down as admin expenses or cost of goods sold. I have been running a freelance web design business for a year now and I pay for a web hosting server to use for my clients’ websites. So will this go down as an admin expense or cost of goods sold? I am not sure because I need this or my business would not be able to exist but it also provides the client with a service that I am charging them monthly for hosting.

    Also I pay for software/plugins to add functionality that are used on each and every website not for a particular client so does this fit under the “Would I have incurred this expense if I did not make this sale?”

    Any help would be greatly appreciated. Thank you.

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