Welcome to this week’s installment on key metrics everyone should be monitoring to measure your organization’s financial health! Head over to our Youtube channel, and take a look at these articles from Investopedia to learn more.
Today we want to talk about profit margin, and you may be thinking, “Well you just talked about gross profit,” and yeah we did… but there’s other profit margins to be concerned with! Actually, there are three you want to monitor. We’ve talked about gross profit, and that’s really the margin where you determine whether or not you’re making money on selling your product or service. There’s operating profit margin, and then there’s net profit, which is after everything.
Operating profit margin will come with a lot of different names. It’s very important to measure, because that’s after you take on overhead. What’s overhead? That’s what it costs you to be in business. You think of these as fixed costs. You might have office rent, office payroll, telephones and the like, etc. So you take gross profit, then you can deduct your overhead, and that gives you an operating profit. Other names for operating profit will be earnings before tax, or EBIT in the financial world, like the stock market. If you’re researching a stock, you’ll see something called EBITDA, which is earnings before interest, taxes, depreciation, and amortization. Another quick way to say that is operating cash flow. How much cash was generated by the business before you did things like pay interest on loans and taxes other non-cash expenses, like depreciation and amortization. So operating profit is closely related to EBITDA, the very important measure that a lot of investors or bankers might be interested in.
Then there’s net profit. After operating profit, you’re going to deduct other things that are business expenses, but aren’t necessarily as related to everyday operating of the business. Like above, there’s interest, there’s income tax expenses, depending on what type of entity you are. If you’re an LLC or S corporation, you may not have income tax expenses, but almost every business has some other expenses. That would go sort of below EBITDA, and after everything, then you get net profit. In the accounting world it might be called net income.
You actually need to monitor all three of these: gross profit, operating profit, and net income. It is challenging to get an SBA loan if you don’t have positive net income. You might have a cash flow for days, but you need to show a net profit in order to qualify for some financing.
So all of this is part and parcel to financial analysis, which needs to be done as a part of planning and forecasting, and that’s what we do here at Harvard Grace! If we can help you with that, let us know.