To understand how your business is truly performing, you need to look beyond just your sales revenue. A growing topline is great, but it means very little if you don’t have a healthy bottom line.
To get a truer picture of how your business is actually performing, you need to take your costs into account. Here are some of the key metrics to consider.
What is gross profit?
Gross profit is your revenue minus your cost of goods.
Cost of goods refers to the costs directly associated with producing your goods and services. That may include the cost of inventory or raw materials used to manufacture a product, equipment costs, transport, warehousing, import costs, currency exposure risk and direct labour costs including on-costs which are tied directly to production.
Gross profit is an important metric to measure as it highlights the company’s capacity to operate profitably, over and above the direct costs of business.
Here’s an example of how to calculate gross profit.
Figure 1 – Monthly Gross Profit
| Income | |
|
Product 1 sales |
$10,000 |
|
Product 2 sales |
$15,000 |
| Total Income |
$25,000 |
| Less Cost of Goods | |
|
Raw materials |
$5,000 |
|
Freight |
$2,000 |
| Less Cost of Goods |
$7,000 |
| GROSS PROFIT |
$18,000 |
What is net profit?
Net profit is your revenue minus your cost of goods and all other indirect costs.
That will include the ongoing costs of operating your business (also known as overhead) such as marketing, indirect employee costs including on-costs, office space, sales, advertising, customer service, internet and so on.
Net profit is an important metric to measure as it highlights your actual earnings, taking into account both direct and indirect costs. Known as the bottom line because net profit is usually the bottom line on a profit and loss statement, this metric will showcase if your costs are putting too much pressure on profitability.
Here’s an example of how to calculate net profit.
Figure 1 – Monthly Net Profit
| Income | |
|
Product 1 sales |
$10,000 |
|
Product 2 sales |
$15,000 |
| Total Income |
$25,000 |
| Less Cost of Goods | |
|
Raw materials |
$5,000 |
|
Freight |
$2,000 |
| Less Cost of Goods |
$7,000 |
| GROSS PROFIT |
$18,000 |
| Less Operating Expenses | |
|
Bank fees |
$10 |
|
Bookkeeping Expenses |
$80 |
|
Insurance |
$80 |
|
Motor Vehicle Expenses |
$100 |
|
Travel |
$20 |
| Wages & Salaries |
$5,000 |
| Website Expenses |
$25 |
| Total Operating Expenses |
$5,315 |
| NET PROFIT |
$12,685 |
What is EBITDA?
Another way to understand earnings is through EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation). EBITDA measures profitability, but also factors in depreciation and amortisation.
Depreciation and amortisation allocate the costs of assets over time. Depreciation accounts for physical assets such as machinery, buildings, equipment, furniture or vehicles. Amortisation accounts for intangible assets such as patents, trademarks or copyrights.
EBITDA can be calculated using operating income or net profit. Depreciation and amortisation are then added.
Here’s an example of how to calculate EBITDA using net profit.
Figure 3 – Monthly EBITDA
| Net Profit |
$12,685 |
| Plus Depreciation & Amortisation |
$7,500 |
| Plus Net Interest Expense |
$2,000 |
| Plus Taxes |
$2,500 |
| EBITDA |
$24,685 |
Why do these metrics matter?
Ultimately each metric has value as a way to uncover your business’ profitability. This will give you an idea of business performance at any given time. More importantly, when these metrics are tracked over time, you can identify trends. If the metrics are trending upwards, that means your bottom line is growing, either parallel to a growth in the topline or through reduced costs. If the metrics are trending downwards, that means your bottom line is declining which either means your topline is also declining, or your costs are growing at a faster rate than revenue.
Net profit, gross profit and EBITDA are just the tip of the iceberg when it comes to understanding how your business is performing. Contact us today to find out how we can help you measure, forecast and maximise performance in your business.
At Keeping Company, we’re not just accountants, we’re business people too. With our counsel, your business can reach its full potential.
We have a team of experts; Cloud Accountants, Business Advisors, Finance Specialists working together and ready to help, contact us today.
For all media enquires please contact Tracy Miller, CMO, Keeping Company 0414 898 452.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.