The business world has many terms that are crucial to success, but some of them aren’t always intuitive or self-explanatory. Whether you work in marketing, sales, finance, operations, or just manage the day-to-day operations of your small business, knowing these terms will help you speak the same language as other professionals in your field and do your job more effectively.
Gross margin is a measure of profit that takes into account only variable costs associated with producing and selling goods or services. It is calculated by subtracting all costs directly associated with a product or service from its sales revenue. Calculating gross margin involves determining what to include in your calculations and where to draw boundaries around items you should or shouldn’t include. The basic formula for calculating gross margin looks like: Gross Margin = Revenue – Cost of Goods Sold (COGS)
Also referred to as variable costs, operating costs are expenses that fluctuate directly with changes in production. Examples of operating costs include raw materials and labor. When looking at a company’s total cost structure, make sure to consider not only its direct costs (such as labor and materials) but also its indirect ones (like facilities-related expenses). In general, companies can control their direct expenses; however, they can’t control what happens outside of their business operations that might affect indirect costs.
A prepayment is a sum of money paid or set aside at an earlier date than normal, to take advantage of favorable terms. Often, it refers to rent payments for property owned by another party. Businesses also prepay expenses in advance, such as an insurance premium or interest on debt before it is due. Prepaid assets are usually booked as current assets in accounting because they can be quickly converted into cash and don’t require any further investment (and thus risk) on behalf of management.
General and Administrative Expenses
General and administrative expenses are a type of overhead business expenses. G&A, as it’s commonly referred to, is all about running your business in an efficient manner. While some businesses might have a more generalized list of G&A items (like office supplies), others may break down G&A into subcategories that cover specific departments or tasks (like advertising and sales). Regardless of how you choose to categorize it, spending your money wisely is crucial for profitability. That’s why knowing how to define general and administrative expenses and then tracking them accordingly can help you make better business decisions down the road. Here’s a closer look at what general and administrative expenses are all about: How do general and administrative expenses differ from other types of overhead costs?
Net Operating Income (NOI)
Net operating income is a measure of financial performance that accounts for all sources of income (after expenses) from an investment property. NOI is calculated by subtracting net operating expenses and debt service payments from total gross income, then adding in depreciation and amortization to obtain a dollar amount. By comparing your actual NOI with your budgeted target or desired goal, you can see how effectively you are managing costs and maximizing profitability. There are two components of NOI: gross rents less vacancy & credit losses plus property taxes plus operating expenses less vacancies & credit losses, minus interest expense. The definition also includes debt service, depreciation and amortization.
The return on investment (ROI) is a calculation used to evaluate if a specific business or marketing strategy was profitable. To find ROI, you need to add up all of your revenue and subtract that number from your total costs. If your net profit (or what’s left over after subtracting cost from revenue) is positive, then your return on investment was good. Example: Your company invested $10,000 in social media marketing last year and earned $20,000 in sales during that time. Your ROI would be $10,000 divided by $10,000 multiplied by 100 percent—or 10%. Your company made money off its marketing campaign because it spent less than it earned. This means you should continue investing in social media marketing to earn more profits next year.
Capital Expenditure (CAPEX)
Capital expenditure (CAPEX) is a company’s investment in non-current assets such as property, equipment, machinery, and data systems. This term is most often used in reference to a business. CAPEX may also be referred to as capital spending or CAPX. Essentially, it is money that has been budgeted for investments over a given period of time—typically one year or more—and that can be used to make large purchases. Businesses consider capital expenditures carefully before investing because they are not offset by an immediate increase in revenues. In other words, any additional cost associated with purchasing new assets does not create value until after those assets have been purchased and have had time to put toward their intended use.
Return on Investment (ROI)
ROI is a key business term used to determine whether or not an investment will yield a positive return. Essentially, it measures how much money you put into something and how much you earn (or expect to earn) in return. For example, let’s say that you buy a new car for $10,000 and sell it one year later for $5,000. You’ve lost $5,000 on your investment. But if you bought 100 shares of stock at $10 each and they’re now worth $15 apiece, your ROI is 50 percent ($500). While calculating ROI requires adding up numbers, it helps that most stockbrokers offer free online tools to help out; another great resource is your local library’s business reference section.