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Turnover, Gross Profit, Net Profit, EBITDA


A while back I was watching an episode of Dragons Den that reminded me of the confusion that abounds around the words: turnover, gross profit, net profit, profit margin and a bunch of other terms that have everything to do with how you view the profitability of a business.

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Turnover or T/O

This is your total sales figure. Literally, in money terms, how much you sold during a particular period (usually your financial year). Turonver To Date means the turnover so far this year. From this you can start to make a prediction of your total turnover for the year. If you have professional indemnity insurance you will need to know this. Most policies allow a degree of error of 50% (to make up for the uncertainty factor), but check your insurance small print. Never confuse turnover with profit. One last thing, always quote turnover excluding sales tax or VAT. If you quote turnover including tax, any potential investors will run a mile (they will see you as someone who likes to inflate figures).

Gross Profit

If all you sell is a service. And there are no costs directly involved in supplying that service, then your gross profit is the same as your turnover. However, if you resell other peoples’ goods or services, manufacture things for resale or do have costs directly involved with what you do, then you need to remove those costs from your sales in order to arrive at your gross profit. Typically these costs will be held an account called Cost of Goods Sold (aka Cogs). If you sell mainly services, this is often shortened to simply Cost of Sales (COS). Here’s a simple example: You buy a widget at a cost of 100 and you resell it for 200. If you sell just one of these, your turnover will be 200. However, your gross profit will be 100 (because you must subtract the cost of the goods sold).

Gross Margin

Using the previous example, the gross margin is 50%. Gross Margin = Selling Price less Cost Price divided by Selling Price multiplied by 100.

Markup

Again, using the previous example, we marked up the product from 100 to 200, which equals a 100% markup.

Net Profit

There are multiple versions of this! The bottom line is your turnover less all costs. Your costs are not only Cogs and overheads but also depreciation of your assets, any amortization of loans and of course your tax liability on the profit made. Accountants use different abbreviations to show exactly what degree of profit they are reporting. The most common is EDITDA.

EBITDA

Earnings Before Interest, Taxation, Depreciation and Amortization. In other words your turnover less Cogs, overheads and other expenses. You can quote on any subset of this. For example: EBIT = Earnings Before Interest and Taxation (so here we are including depreciation and amortization).

Learn the above and you will impress any investor (and bank manager).

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    Quentin Pain
     

    Quentin Pain helps people thinking of starting a business and those already in business achieve success. Visit QuentinPain.com Today.

    Click Here to Leave a Comment Below 13 comments
    Dan

    Hello,
    I am looking to buy into a business and I was looking for advice on the valuation. The business has been around for about 12 years and has been growing at about 15% the last 4 years. Their EBITDA for 2015 was $750k according to my accountant who looked at their tax return. How would you value their company based on that? This company is a snack food company.

    Reply
      Quentin Pain

      The only valuation that matters is what you are willing to pay. You might want to look into market saturation and what plans there are for even more saturation in the future. Think about if this was your business and you wanted to sell it. How much would you want? You can find a wealth of information on the internet with all sorts of multipliers of profit – but they don’t really mean very much (with or without EBITDA – ie. real net profits or EBITDA). Here’s the Wikipedia entry on multiples: https://en.wikipedia.org/wiki/Valuation_using_multiples

      Reply
    Quentin Pain

    I’ve only just realised that the comments on this page were turned off – hence the huge gap in dates! But they’re on again now, so if you have any questions or comments, please go ahead and post them here. Thank you.

    Reply
      Peter Kennett

      Hi Quentin,

      I have a question I hope you can clear up for me.
      I am interested in buying a business (hotel) which claims a turnover of $520,000 per annum, with a 62% G.P.
      My question is – is the G.P. worked out on the turnover, or do I need to know the turnover less operating costs to work out the G.P?\
      Thanks.

      Regards,

      Peter.

      Reply
        Quentin Pain

        Hi Peter, GP is total sales (turnover) less the cost of those sales. So you only deduct the costs that are directly related to the sale. In its simplest form it would be what it cost to buy the goods being sold. Eg. If you buy something for $10 and sell it for $20 your GP is $10. If, however it also cost you $3 to ship it, then your GP would reduce to $7. Any costs that cannot be directly attributed to what it cost you to buy and sell goods are not included in GP. So for example, office rent and electricity won’t be included (they will be taken off the GP to find net profit – or EBITDA). In the case of a hotel, I would want to see net profit, not GP.

        Reply
    Jean-Claude

    C’etait fantastique. Merci beaucoup!

    Reply
    Brian

    Nicely put and something my managing director should learn to understand!

    Reply
    Kevin Green

    I’ve just subscribed to your free course. Your explanation of terms on this post is nice and simple, removing some of the mysteries – thanks. I work in the charity/education sector, so I’m more interested in accounting for the provision of teaching services than widgets! Would you be able to write a charity rather than a business version of T/O, GP etc?

    Thanks, Kevin

    Reply
      Quentin Pain

      Thanks for the comment Kevin. There is only one word you really need to know and that is ‘Revenue’. For sales accounts you can use ‘Contributions’ or ‘Donations’ or ‘Project x’. Expenses remain as they are. You are basically reporting on the revenue and expenses of the charity/not-for-profit. So in a nutshell the word “Revenue’ replaces all things ‘sales’ and ‘P&L’ etc. It is of course all semantics, and the important thing is that you report everything with terms that make it plain what you are doing. You can happily use the word ‘sales’ for income accounts if it makes sense to what you do (many charities sell stuff as well as take in donations).

      Reply
    Frank Cook

    I too have noted the confusion on Dragons Den.

    I think it is helpful and traditional to distinguish between margin and markup as follows –

    Sales £100
    Purchases £60
    Gross profit £40
    Margin% 40/100 i.e. 40%
    Markup% 40/60 i.e. 67%

    Frank

    Reply

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