We are a society fascinated by numbers. People will quote sports stats of their favorite stars (everything from batting averages to quarterback ratings to field goal percentages), how much their favorite actress made for her latest film or how many characters they can text per minute on their blackberry.
So why with all this focus on numbers, does the simple mention of financial statement send a chill down the spine of most small business owners? It’s obviously not a fear of numbers! The best I can tell, it’s probably more the result of owners simply not being familiar with the terminology that is used and how it can be interpreted. For instance, what’s the difference between Sales and Revenue? How about Gross Profit vs. Net Profit? What exactly is Book Value after all?!?!
These are all great questions and easy enough to answer and help someone understand who truly has the desire…and it’s really not that hard! I equate the look I receive from business owners when I mention SG&A to the look I receive from my wife when I talk about Grady Sizemore’s OBP. It’s not so much the “huh?” look as it is the “what are you talking about and why should I care?” look.
What we have found is that most financial professionals are stuck in using their own lingo and acronyms that sounds like an altogether different language to someone outside the financial circles. Communication is key in everything you do. If you’re using a bunch of buzzwords or acronyms, be careful to understand your audience and their perspective. It’s incumbent upon financial professionals to do a better job of communicating effectively with business owners vs. impressing them with all the cool lingo they know, while most times not even realizing the disconnect exists.
To make sure I communicate properly here, let me explain some of the acronyms I have used as well as answer the questions I’ve posed above as well.
As for Sales and Revenue, there really is no difference. These are just two names used to describe the same thing: how much (in dollar terms) did you sell of your product or service. It will show up at the top of your income statement (also known as a profit & loss statement) as Sales or Revenue.
Gross Profit is the result of the following formula (Sales – Cost of Goods Sold) whereas Net Profit is the result of the following formula (Sales – Total Costs). Now as part of my answer, I may have created some more confusion by introducing the term Cost of Goods Sold (or COGS as it is sometimes called), which simply represents all of the direct labor, material, and overhead that goes into providing your product or service.
Book Value is simply the result of this formula using your Balance Sheet (Total Assets – Total Liabilities). Another way to think about Book Value is that it represents all the money that has been invested in your business plus all the profits from your business since it started minus any dividends or distributions that have been paid to shareholders. Book Value is sometimes referred to as Net Worth, which is a bit confusing as well since most business owners wouldn’t sell their business for that figure.
SG&A is short for Selling, General & Administrative expenses. These are all the costs of running a business that are not directly correlated to deriving Revenue. Examples include rent, insurance, dues & subscriptions, and tax preparation fees. These are all expenses that are required for you to be in business and are often referred to as Overhead or Fixed Costs.
Last, but not least, OBP is short for On Base Percentage and is a measure for how often a baseball player reaches base (i.e. basically adjusts batting average to include the number of times someone walks or is hit by a pitch). Wikipedia has a great definition as well as a formula for calculating OBP.
Let me know how I’m communicating!