Margin, gross, operating, net or EBITDA – what should a business owner be looking at and what is the difference between them? There are many different performance indicators, and each one is important in its own way. Thankfully, they are not hard to understand, and such knowledge will be valuable to any business owner or manager.
There are several basic indicators that you can use to assess the effectiveness of your business, regardless of your niche and industry. Let’s look at them all and choose the one you need.
This article was written with the support of Omega, an online platform that allows entrepreneurs to create a multi-currency IBAN account for global business operations.
Marginal Profit
Marginal profit is sales minus variable costs. Variable costs are those that are directly related to the volume of products manufactured, goods sold, or services rendered.
For example:
- In making cakes, variable costs would be flour, eggs, and nuts.
- In retail, variable costs would be the cost of purchased goods.
- For an IT company, variable costs might be the salaries of programmers hired for a project. There is a project – there is a cost, no project – no cost.
Marginal profit tells you how much money you have left to cover fixed costs. And margin is an indicator that tells you how many percent the marginal profit will be in the selling price of the product.
Margin is very important in calculating the break-even point. Calculating margins is the first step in setting up a full-fledged management accounting program.
Gross Profit
Gross profit is revenue excluding variable costs and fixed costs. If you sell goods, gross profit is revenue minus cost of goods sold. But if you say “cost of services” – everyone will understand you and it won’t be wrong.
Fixed costs are those that are not variable, but are also related to the production activities of the company. With a small increase in sales, fixed costs will not change, but without them, production, sales or services will not be possible. Your rent for the commercial building could be an example of the fixed costs.
Gross profit shows how much money you have left over for additional expenses not related to production.
Operating Profit
Operating profit (or profit on sales) is gross profit minus indirect costs. This type of profit gives you an idea of how much money is left over for all sorts of contingencies, incidentals and, of course, dividends.
Net Profit
Net profit = operating profit + other income – other expenses – income tax.
Other expenses include interest and the unexpected costs. Please note that dividends paid to the owners of the company do not reduce net income.
EBITDA
EBITDA means earnings before interest, taxes, depreciation and amortization. Western accountants understand depreciation as the amortization of fixed assets and amortization as the amortization of intangible assets.
The difference between EBITDA and operating income is just in the amortization. This ratio is needed to understand how effective it will be to buy a company with borrowed money. EBITDA shows how much money the company will have left to pay back the loan.
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