Every business aspires to make a profit which is where you sell for more than you pay. However, there are many types of profit that are used – many for different reasons. This post is designed to look at the common ones (and alternate terms or common abbreviations), explain what they are and what they get used for. I will start from the top of the profit and loss:
Gross Profit (also GP or gross margin or GM)
This is what a business makes from the direct activities of whatever it sells. It includes all sales (including time payment discounts, rebates, volume discounts, returns, etc) and all costs directly involved in the creation and its sale (materials, labour costs to make, delivery costs, etc). This is very useful to understand whether what a business sells has high margins or not – divide the GP by total sales and this gives the margin.
Net Profit before tax (also NPBT or operating income)
This is gross profit less all the general and operating costs and interest paid. Effectively it shows how efficient a business is converting the gross profit made on what it sells into profit. This is where overhead costs that are out of control become very apparent.
Net profit after tax (also called NPAT)
As the saying goes, the only two certainties in life are death and taxes. This is where whatever income tax is owing to the government is deducted. This does not include GST as it is effectively a net tax only (GST collected less GST paid) and is generally shown as a general expense.
Earnings before interest and tax (also called EBIT)
This is effectively net profit before tax with any interest paid costs added back in. It is used quite often in assessing the value of a business. The argument is that the way a business is funded does not affect a potential purchaser because they may vary its funding structure, so looking at what type of earnings multiple may be applied is done before interest costs.
Earnings before interest, tax, depreciation and amortisation (also called EBITDA)
This is the EBIT figure but with depreciation and amortisation added back. Amortisation is the same as depreciation but applies to non-physical assets (so goodwill is amortised). As financial accounts are prepared on an accrual basis, EBITDA is quite often used as a proxy for cash earned by a business as depreciation and amortisation are not cash items. Again it is widely used in assessing business values. Be very careful trying to use EBITDA as a business cash flow figure – cash flow is impacted by movements in balance sheet items like debtors and creditors.
I hope this makes all the funny acronyms a bit clearer.
Marshall Vann – Realistic Business Solutions
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