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.
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.
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).
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.
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!