What is a business?
A business is an organization or enterprising entity that produces and sells goods or provides services in exchange for payment. Its basic economic purpose is to create and deliver value to customers and, in most cases, to generate revenue in excess of costs.
Key definitions
– Business plan: a written document that sets out a company’s objectives, strategies to reach them, and key operating assumptions. Lenders and investors commonly ask for one before they provide capital.
– For‑profit: an entity that aims to generate a surplus (profit) for owners or shareholders.
– Nonprofit (not‑for‑profit): an organization that exists primarily to pursue a social, charitable, cultural or educational mission rather than to distribute profits to owners.
– Juridical person (legal person): a legal construct that lets a company own property, borrow money, enter contracts, and be a party in court, separate from its owners.
– Gross receipts: total revenues or sales before expenses; often used in sizing and tax rules.
How businesses vary
– Legal form and ownership: Businesses can be sole proprietorships (owner-operated), partnerships, limited liability companies, or corporations. The chosen form affects taxes, liability, and registration obligations.
– Size: Small businesses are typically owner-managed and often have fewer than 100 employees. In the U.S. there were about 34.8 million small businesses employing roughly 59 million people (2024). Mid‑sized firms don’t have a single federal definition; some municipal frameworks treat
them by employee count, annual revenue, or other local thresholds — so “mid‑sized” is context‑dependent. Size interacts with regulation, access to capital, and management structure: larger firms face more complex reporting and governance requirements; smaller firms often rely on owner‑managers and simpler recordkeeping.
Industry and classification
– Classification systems: Economies classify businesses by industry using schemes such as NAICS (North American Industry Classification System) or ISIC (International Standard Industrial Classification). These codes matter for regulation, taxation, and statistical analysis.
– Capital intensity and margins: Industries differ in capital needs and typical profit margins. For example, software firms often have low marginal cost and high gross margins, while manufacturing typically has higher fixed capital and lower margins.
Lifecycle stages
Most businesses pass through broadly similar stages. Recognizing the stage helps set goals and choose metrics.
1. Idea / seed: Concept validation, small or no revenue, focus on product‑market fit.
2. Startup: Early revenue, high cash burn, customer acquisition focus.
3. Growth: Scaling revenue, hiring, expanding distribution; unit economics become crucial.
4. Maturity: Slower growth, emphasis on efficiency and margin improvement.
5. Decline/renewal: Market contraction or disruption; options are reinvention, divestiture, or exit.
Common business objectives
– Profit maximization: Increasing net income after all costs.
– Growth: Expanding revenue, market share, or geographic reach.
– Cash flow stability: Ensuring liquidity to meet obligations.
– Risk management: Diversification and hedging against shocks.
– Social or environmental goals: Pursuing stakeholder or mission objectives (common in nonprofits and B‑corps).
Revenue models (how businesses make money)
– Sales of goods or services: One‑time or recurring transactions.
– Subscription: Periodic fees for ongoing access (SaaS).
– Licensing and royalties: Charging for use of IP.
– Advertising: Monetizing attention (media platforms).
– Transaction/commission fees: Taking a cut per transaction (marketplaces).
– Freemium: Free basic offering with paid upgrades.
Key financial metrics and formulas
Define jargon on first use and give formulas you can compute quickly.
– Revenue (Sales): Total money received from customers.
– Cost of goods sold (COGS): Direct costs to produce goods/services.
– Gross margin: (Revenue − COGS) / Revenue. Expressed as a percent.
Example: Revenue = $500,000; COGS = $200,000 → Gross margin = (500,000−200,000)/500,000 = 0.6 = 60%.
– Operating income (EBIT): Earnings before interest and taxes; Revenue − COGS − Operating expenses.
– Operating margin: Operating income / Revenue.
– EBITDA: Earnings before interest, taxes, depreciation, and amortization.
Formula: EBITDA = Net income + Interest + Taxes + Depreciation + Amortization.
Example: Net income $80k, interest $10k, taxes $20k, depreciation $15k, amortization $5k → EBITDA = 80+10+20+15+5 = $130k.
– Return on equity (ROE): Net income / Shareholders’ equity — measures profitability relative to owner capital.
– Free cash flow (FCF): Cash generated after capital expenditures. Simple formula: FCF = Operating cash flow − Capital expenditures.
Funding sources
– Bootstrapping: Using owner funds and operating cash flow.
– Debt: Loans and bonds; must be repaid with interest (priority in bankruptcy).
– Equity: Selling ownership shares; dilutes existing owners but no fixed repayment.
– Venture capital and angel investment: Equity financing aimed at high‑growth firms.
– Grants and subsidies: Often for research, nonprofits, or public‑interest projects.
Legal and tax considerations (checklist)
– Choose an appropriate legal form (sole proprietor, partnership, LLC, corporation) based on liability, tax, and fundraising needs.
– Register business name and obtain required licenses/permits.
– Set up tax registrations: employer ID, sales tax, payroll withholding where applicable.
– Maintain corporate formalities if using a juridical person (separate legal entity): minutes, capitalization, and documented transactions.
– Comply with employment laws and reporting.
Practical checklist for evaluating a small business (quick due diligence)
1. Confirm legal entity and registrations.
2. Review three years of financial statements (income statement, balance sheet, cash flow).
3. Compute gross margin, operating margin, and EBITDA trends.
4. Check customer concentration: top 5 customers’ share of revenue.
5. Review contracts, leases, and contingent liabilities.
6. Assess working capital needs: current assets − current liabilities.
7. Evaluate management team experience and key‑person risk.
8. Identify industry risks and regulatory exposure.
Worked numeric example: assessing cash runway for a startup
– Monthly cash balance: $120,000.
– Monthly net cash burn (expenses minus revenue): $30,000.
– Runway (months) = Cash balance / Monthly burn = 120,000 / 30,000 = 4 months.
Interpretation: At current burn rate and without new funding or revenue growth, the firm can operate ~4 months.
Assumptions and limits
– Metrics are as good as the underlying accounting. Look for one‑time items (nonrecurring gains/losses) that can distort ratios.
– Industry norms vary; compare businesses to relevant peers or sector benchmarks.
– Legal definitions and thresholds (e.g., “small” or “mid‑sized”) differ by jurisdiction; consult local rules.
Further reading (reputable sources)
– U.S. Small Business Administration — “Size Standards” and starting guidance: https://www.sba.gov
– U.S. Census Bureau — Business and industry statistics: https://www.census.gov
– Investopedia — Business overview and terminology: https://www.investopedia.com/terms/b/business.asp
– North American Industry Classification System (NAICS) — https://www.census.gov/naics
Educational disclaimer
This content is for educational purposes only and not individualized investment or legal advice. Consult qualified professionals for decisions about investing, taxation, or corporate structure.