Accounting has a lot of jargon that many outsiders in small business or any profession for that matter may not understand. So we have developed a guide to help you understand the important terms.
COGS: Cost Of Goods Sold
This term related to the amount of money spent in making the good before it goes to sale. This includes the cost of purchasing the good from the supplier as well as any additional costs incurred getting the product into inventory and ready for sale to customers.
Gross Profit Margin
Now that you know how much your cost of goods were and how much they sold for, you can now calculate the margin which is the Gross Profit. This is the first step in working out overall profitability. The higher the better.
Operating Profit Margin
The gross profit margin doesn’t tell you what it costs to operate your business. Operating expenses are those incurred as a result of normal business operations including R&D etc.
Sales Revenue – Operating Expenses – COGS = Operating Income / Sales Revenue = Operating Margin.
Earnings before interest and taxes is effectively your operating profit.
The calculation of EBIT is:
EBIT = Revenue-COGS-Operating Expenses
Earnings before interest, taxes, depreciation and amortisation. This determines how much you pay or get back from the tax man.
EBITDA = Revenue – Expenses (excluding tax, interest, depreciation and amortization)
Net Profit after Tax is your bottom line. It’s what your accountant will tell you you have made after all your revenues and expenses have been added and subtracted
The current ratio is the simplest of all business ratios and simply lets you know that your business has enough current (liquid) assets to satisfy current debts. It can include inventory, which will be expected to be sold.
Current Ratio = Total Current Assets / Total Current Liabilities
Some call it the “acid test” as it is more conservative than the current ratio as it excludes inventory, which has an uncertain sales pipeline and price, from the cash generation projection. The larger the better means you have more cash available.
Quick Ratio = [Cash on hand (including marketable securities) + Receivables] / Total Current Liabilities
Debt to equity
This one is straightforward, telling you the leverage you are employing in your business. The lower the better.
Debt to Equity = Debt held / Shareholder Equity
The number of products you sell from your inventory.
Inventory Turnover = COGS/Average Inventory
Average inventory is calculated as:
Inventory @ Start + Inventory @ End / 2
Accounts Receivable turnover
The accounts receivable turnover ratio simply tells you how often you can turn over your debtor’s ledger during a year. It can help with cash flow planning and knowing if it is increasing can be an early warning that clients are under pressure.
Accounts Receivable Turnover ratio = Net Credit Sales/Average Accounts receivable.
Year on Year is simply a measure on where you are now in terms of sales growth compared to where you were a year ago.
YOY Growth rate = (Sales Now – Sales 12 months ago)/Sales 12 months ago
Month on Month sales is the same as above except over a shorter time frame.