If you run a small business, or are interested in starting one, you’re probably familiar with the overwhelming amount of financial jargon—and the furrowed brow that comes from trying to understand what it all means.
Having a basic understanding of financial language—even if you don’t directly manage your business’ bookkeeping and accounting—can help you make more informed decisions about your business and better articulate and achieve your goals. In this blog, we review four common financial terms, what they mean, and how they’ll help you build a resilient business.
- Gross revenue. Revenue is the total amount of money generated from business operations over a specific period of time, such as every month or quarter. In other words, it’s all the money made before expenses or other costs.
For for-profit businesses, this money comes from the sales of goods and/or services that are central to the business’ existence (for example: the sale of coffee drinks in a coffee shop). Gross revenue also excludes any discounts, returns, or price adjustments made on your good(s) or service(s). This helps business owners understand their full sales numbers before any adjustments—such as giving students $2 off any coffee drink—so they can appropriately manage business growth.
- Cost of goods sold (COGS). COGS is the amount of money your business must spend to sell your goods or services. This can include direct costs of employee labor (for selling or providing the good or service) and materials (for producing the good).
Returning to our coffee shop example, COGS would include the money a business owner spends on coffee beans, milk, the espresso machine, cups, lids, napkins, and more—in other words, everything that is necessary for a customer to receive an excellent latte.
- Gross profit. Gross profit is the amount of money a business makes after deducting the costs associated with producing and distributing the good or service.
Revenue – COGS = Gross Profit
For example, if your revenue is $20,000/month and your COGS is $5,000/month, then your gross profit is $15,000 a month.
By assessing the relationship between total revenue and production costs, gross profit can help business owners understand why and how their profits are increasing or decreasing.
For example, if the coffee shop owner found a way to cut their monthly production and distribution costs by sourcing locally roasted coffee beans instead of beans roasted across the country, but their monthly revenue stayed the same, their gross profit would increase. This gross profit would then provide insight into how profitable their coffee shop can be based on any adjustments in their COGS.
- Net profit. Net profit is the amount of money left after subtracting all costs and expenses associated with running their business—not just the COGS (like in gross profit). In addition to subtracting COGS, business owners may also subtract the rent for their business’ space, any operating expenses (like electricity and water usage), tax payments, interest, debt, and more.
Revenue – Total Expenses (COGS + operating expenses + taxes + interest + debt, etc.) = Net Profit
Net profit is the clearest indicator of a business’ profitability and organizational effectiveness, and it also indicates how much money the business owner has available to them. This data helps business owners make informed decisions and achievable goals related to growth and sustainability.
Understanding these four financial terms is the foundation for building a resilient, profitable business that provides high-quality goods and services and takes care of its employees. It leaves business owners better equipped to ask insightful questions, create measurable goals, and set their business up for long-term success.
Black Gallina takes the stress out of running a small business by providing accounting and bookkeeping, operations, and strategic planning support. Reach out to learn more about what we can do for you.