Business Terms and Equations

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  1. Revenues
    the total amount of money that the company receives from customers by selling its products.

    Example: You sell plane tickets to your customers. The total amount of money you collect from customers in exchange for plane tickets (and any additional services you provide) is your company’s revenues.

    • Revenues = Volume x Average Price
    • Revenues = Total Market Sales x Market Share.
  2. Costs
    Costs, or expenses, are the total amount of money that the company pays to its various suppliers.

    Example: money that the company pays for fuel, leasing airplanes, the salaries of the crew, as well as expenses such as the cost of running their headquarters, their website, or even taxes and interest on loans.

    Cost=Revenues (1-profit margin)
  3. Fixed and Variable costs
    Variable costs are the costs that increase with higher sales or higher production.

    Fixed costs are the costs that would have to be paid regardless of how much is produced.

    In other words, variable costs change with the level of business activity, while fixed costs don’t.

    Example: Let’s imagine you are the CEO of a handbag manufacturer. The cost of the material you use to manufacture the bags is a variable cost: the more bags you produce, the more leather you will need. If one day you produce no handbag, then you don’t have to pay for any extra material. By contrast, the rent you pay for the store has to be paid every month, regardless of whether you sell or produce any bags that month.
  4. Labour costs
    Can be either fixed or variable.

    As a CEO, your salary is a fixed cost as it will be paid independently of how many bags the company produces. However, during periods of peak production you might hire extra workers at your factory and their salary will therefore be a variable cost.
  5. Profits
    Profits, also known as net income or net earnings, represents the money left to the owners or managers of the business after all expenses have been paid.

    • Profits = Revenues – Costs
    • Profit=Revenues × Profit margin

    Profits are always calculated over a certain period of time – either a quarter or a full year. If you are given fixed and variable costs, you would first have to calculate total costs over the period of time studied, before being able to calculate profits.
  6. Gross revenues vs. net revenues
    Gross revenues will be recorded as the money that the company would have received if it had charged the full price to its customers, while net revenues are the amount of money that the company actually did receive.

    Example: when companies have to deal with goods returned by customers. Apparel retailers often face this situation. The gross sales will then be the total amount of money received by the company from selling its merchandise, while net sales will subtract the value of any goods returned by customers and reimbursed by the company.

    The smallest number, net revenues, is usually the one that matters. It is the one that will be used to calculate profits, since money returned to customers through discounts or reimbursements will not go to the owners of the company.
  7. COGS
    Cost Of Goods Sold, also known as Cost of Sales. COGS represent the total amount of cost that the company can attribute to a particular item they sell.

    Example: For each handbag you sell, you have to buy leather, pay an employee to assemble the handbag, and face some costs to transport and store the good until it is sold. All of those expenses count towards the handbag’s COGS. This is because they can all be traced back to one single item.
  8. Overheads
    costs that cannot be allocated to any particular good sold.

    In the previous example, the costs of a marketing campaign, the costs of employees operating the store or your salary as a CEO cannot be attributed to one particular good and therefore do not fall under COGS.
  9. Gross Profit Margin
    Revenues – COGS/revenues

    The gross profit margin tells us the profit a company makes on its cost of sales, or cost of goods sold. In other words, it indicates how efficiently management uses labor and supplies in the production process.
  10. Growth rates
    Growth rates are a very useful basic tool for businesses as they allow managers to determine whether the company is going in the right direction, and how its performance compares with previous years.

    Growth rates can be calculated for any of the performance measures we defined above: sales, costs or profits.

    Example: you could calculate the growth in revenue between 2014 and 2015 using the following formula:

    Revenue growth = (Revenue(2015) – Revenue(2014)) / Revenue(2014)
  11. CAGR
    Compound Annual Growth Rate. Given a starting quantity and a quantity several years later, the CAGR is the rate at which the quantity would have to grow every year from the first period to reach the amount of the last period.

    For instance, suppose your company generated $100m in revenues in 2013. The next year, revenues grew by 2% to $102m. The following year, your sales grew even faster, by 4%, so that revenues for 2015 stood at $106.1m. The CAGR represents the average annual growth over these two years.

    ((sales 2015)/(sales 2013))^(1/2)-1
  12. Profit margin
    Margins are essentially any of the quantities we may be interested in, divided by net revenues.

    Profit margin = Profits / (Net Revenues)

    Equivalently, you could define the gross profit margin as

    (Gross Profit) / (Net Revenues).

    Since they are always expressed as a percentage, you can say that a company with a higher profit margin is performing better, relative to its size.
  13. Percent increase
    If you are asked to calculate growth by an increase in the percentage.

    Number( 1+%)

    Example: $14bn grows by 20% every year. After two years, how mich will it be?

    14 x (1+.20)=16.8 after 1 year

    16.8 x (1+.20)=20 after 2 years
  14. What percent A is of B
    Divide A by B, then take that number and move the decimal place two spaces to the right.

    Example: $20 is what percent of $57

  15. ROI
    Return on Investment

  16. Total sales
    Total profit/profit margin
  17. Market share
    Revenue/market size
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Business Terms and Equations
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