Chapter 9: Financing and Accounting Basics

Assets = Liabilities + Owners’ Equity

Assets are items the business owns that create future benefit: cash, inventory, equipment, vehicles, and real property. Liabilities are debts and obligations the business owes to others: loans, accounts payable, accrued expenses. Owners’ equity is what remains after liabilities are subtracted from assets, the owners’ stake in the business.

The examples that follow use Hometown Pizzeria, a hypothetical small restaurant, to illustrate each financial statement.

The income statement, also called the profit and loss statement or P&L, describes how much money the business earned and what it cost to earn it over a specific period. Revenue minus expenses equals net income, or profit if positive and a loss if negative. For a business that sells physical products, the income statement distinguishes between the cost of goods sold (COGS), the direct costs of producing what was sold, and operating expenses such as rent, wages, and utilities.

The difference between revenue and cost of goods sold is gross profit. Gross profit tells the owner how much money the business makes on each sale before accounting for overhead. The selling price of a single pizza ($12) minus its ingredient cost ($4) produces a contribution margin of $8 per pizza. That $8 contributes toward paying all other fixed expenses of the business.

The break-even point is the level of sales at which total revenue exactly covers total costs, producing neither profit nor loss. Understanding the break-even point is one of the most practical tools in financial planning, because it answers a fundamental question: how much do we need to sell just to cover our costs?

To calculate break-even, a business must distinguish between two types of costs:

• Variable costs change with the level of sales. For Hometown Pizzeria, ingredients are a variable cost: the more pizzas sold, the more ingredients are needed. Variable costs are captured in the cost of goods sold.

• Fixed costs remain the same regardless of sales volume. Rent is a fixed cost: the pizzeria pays the same monthly rent whether it sells 100 pizzas or 1,000.

Not all costs behave the same way. Correctly identifying which costs are fixed and which are variable is essential for accurate break-even analysis. Utilities occupy a gray area: a base monthly bill behaves like a fixed cost, while usage-based portions fluctuate with activity. For break-even purposes, small business owners typically use a reasonable monthly estimate and treat it as fixed.

The break-even formula is:

Break-Even Point = Total Fixed Costs ÷ Contribution Margin per Unit

For Hometown Pizzeria, with fixed costs (rent) of $3,000 per month and a contribution margin of $8 per pizza, the break-even point is 375 pizzas per month ($3,000 ÷ $8 = 375). Every pizza sold beyond 375 adds $8 to profit. Every pizza short of 375 represents $8 of rent that is not covered.

Break-even analysis helps a business owner understand whether a business model is viable before committing resources. If the break-even point requires selling more units than the target market can realistically support, that is critical information to have before opening. It can also reveal when prices are too low, when costs are too high, or how many units need to be sold before the business becomes profitable.

The balance sheet provides a snapshot of the business’s financial position at a specific point in time. It organizes the accounting equation into three components: assets, liabilities, and owners’ equity, and shows how they balance against each other. A potential investor or lender uses the balance sheet to understand what the business owns, what it owes, and how much equity remains after debts are settled.

Owners’ equity is built from two things: what the owner put in, and what the business has earned and kept. That’s it.

Owner investment is the money or property the owner contributed to start or fund the business. Retained earnings are the cumulative profits the business has made over time that were kept in the business rather than taken out. Add those two together and you have owners’ equity.

The retained earnings column is cumulative, carrying the running total forward each year. In Year 4, a large loss wipes out all prior retained earnings and pushes owners’ equity negative, meaning the business owes more than the owner’s stake can cover. Year 5 shows a partial recovery: the business is profitable again and equity is climbing back toward positive.

The statement of cash flows explains where the business’s cash came from and where it went during a specific period. It differs from the income statement in an important way: the income statement records revenue when it is earned, not necessarily when cash is received. A business can be profitable on paper and still run out of cash if customers are slow to pay or expenses come due before revenue arrives. The statement of cash flows addresses this gap.

The statement of cash flows is organized into three sections:

• Operating activities reflect the cash generated or used by the core business, including customer receipts, payments to suppliers, payroll, and similar day-to-day transactions. Positive operating cash flow indicates the business model is generating real cash.

• Investing activities reflect major purchases of equipment or facilities, significant outlays that the business expects to benefit from over multiple years.

• Financing activities show new infusions of cash from loans, investor contributions, or owner capital, as well as repayments of debt.

Monitoring all three financial statements, monthly at minimum and quarterly and annually for planning purposes, gives a business owner an accurate, real-time view of financial health. Surprises in business finances are almost always the result of not looking frequently enough.

Use the following questions to test your comprehension of this chapter.

1. A friend is starting a small cleaning service in Henderson and is trying to decide between taking out a small business loan and seeking an equity investment from a family member. What are the key trade-offs of each approach? What questions would help her determine which is the right choice for her situation?

2. The chapter describes bootstrapping as a funding strategy that requires scrutinizing every expense and finding creative ways to minimize cash outflows. What does this look like in practice for a new food service business in Las Vegas? Give three specific examples of decisions a bootstrapping food business owner might make differently than one with well-funded investors.

3. A Las Vegas boutique clothing store shows a net income of $12,000 on its income statement for the month, but the owner is struggling to pay her suppliers on time. The chapter explains that a business can show a profit and still run out of cash. In your own words, explain how that is possible and identify which financial statement would give the owner the clearest picture of what is happening.

4. Calculate the break-even point for the following scenario: A Las Vegas dog grooming salon charges an average of $65 per appointment. The variable cost per appointment (shampoo, supplies, disposables) is $12. Monthly fixed costs are rent ($2,200), utilities ($300), insurance ($150), and the owner’s base salary ($3,500). How many appointments per month does the salon need to break even? Is this realistic for a one-person operation?

Angel investor — A high-net-worth individual who invests personal funds in early-stage companies in exchange for equity, typically in addition to providing mentorship and access to networks.

Accounting — The system of recording, classifying, and summarizing financial transactions related to a business, and communicating those results in financial statements.

Assets — Items a business owns or controls that provide future economic benefit, such as cash, inventory, equipment, and real property.

Bartering — The exchange of goods or services for other goods or services without the use of money.

Balance sheet — A financial statement that summarizes a business’s assets, liabilities, and owners’ equity at a specific point in time.

Bootstrapping — Self-funding a business using personal savings and resourceful cost management, without relying on outside investors or loans.

Break-even point — The level of sales at which total revenue exactly covers total costs, producing neither profit nor loss. Calculated as total fixed costs divided by contribution margin per unit.

Contribution margin — The selling price of a unit minus its variable cost. Represents how much each unit sold contributes toward covering fixed costs and generating profit.

Cost of goods sold (COGS) — The direct costs of producing the goods or services sold by a business, including materials and direct labor.

Crowdfunding — Collecting small amounts of money from a large number of people, typically through online platforms, in exchange for rewards rather than equity.

Debt financing — Borrowing money from a lender with the obligation to repay the principal plus interest on an agreed schedule.

Equity — The owner’s claim on the assets of the business after all liabilities are deducted. Represents the net worth of the business attributable to its owners.

Equity financing — Providing funding to a business in exchange for a partial ownership stake. No repayment schedule, but the investor shares in future profits and may influence business decisions.

Financing — The process of raising money for a specific purpose, such as launching or growing a business.

Fixed costs — Costs that remain constant regardless of the level of sales or production, such as rent, insurance, and base salaries.

Gross profit — Revenue minus cost of goods sold. Indicates how much money the business makes on sales before accounting for operating overhead.

Income statement — A financial statement that summarizes a business’s revenue, expenses, and net income over a specific period. Also called the profit and loss statement.

Liabilities — Debts and financial obligations owed by the business to other parties, such as loans, accounts payable, and accrued expenses.

Net income — The amount remaining after all expenses are subtracted from revenue. A positive figure indicates profit; a negative figure indicates a loss.

Pre-orders — Advance purchases made by customers before a product is available, providing cash to fund production or startup costs.

Statement of cash flows — A financial statement that explains the sources and uses of a business’s cash over a specific period, organized into operating, investing, and financing activities.

Variable costs — Costs that change in direct proportion to the level of sales or production, such as raw materials and direct labor tied to output.

Venture capitalist — A professional investor or investment firm that specializes in funding early-to-growth-stage companies with high growth potential, typically in exchange for significant equity and board representation.

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University of Nevada, Las Vegas. (n.d.). InnovateNV.

University of Nevada, Las Vegas. (n.d.). President’s Innovation Challenge.

Woodhull-Smith, M. (2024). Introduction to entrepreneurship. NC State Pressbooks. (Licensed CC BY-NC-SA 4.0)