5 Essential Finance Terms
By Shari Steinbach, MS RDN, RDBA Contributing Editor
In your role as a retail dietitian, it is important to have an understanding of key retail finance terms so you can analyze corporate financial statements, know what the overall health of your company is and recognize where your retailer’s strengths and weaknesses are. This information can also help you identify the areas where your work provides value and assist you with defining meaningful measures of success. Let’s start with this basic finance terminology:
- Cost of Goods Sold (COGS) – In retail businesses, cost of goods is the cost of the inventory the business sells. It is calculated by adding the opening inventory to the purchases at cost, minus the closing inventory at cost. This calculation may include markdowns or freight. This is usually accounted for on a sale-by-sale basis, often using a perpetual inventory system within the retailer’s point of sale software. COGS is a critical number on the profit and loss statement of inventory-based companies. Without it, a retailer cannot determine gross profit which is a crucial metric to know when trying to maximize the profitability of a company.
- Inventory Turnover: This ratio measures how often your entire inventory is sold and replaced within a given period of time. It is calculated as sales/average inventory when using retail price or cost of goods sold/average inventory when using cost. This will vary by category and merchandise. Shrink may be considered here as it reflects the difference between the amount of inventory shown on the books and the actual physical inventory when counted. Shrink includes food waste and theft.
- Gross Margin or Gross Profit: This number is calculated by taking sales and subtracting the costs of goods sold. This is simply the difference between what an item cost and the price for which it sells. This can be reported as a percentage or in dollars. Dollars is great for knowing the total money yielded by the product category in your store whereas percentage is great when you comparing categories within the store.
- EBITDA: EBITDA stands for "Earnings before interest and taxes, depreciation and amortization." This earnings calculation includes only sales minus cost of goods sold and general and administrative expenses. EBITDA is a description of the profit the company would have had if it didn't have to pay interest expenses on business debts and any taxes, and before any calculations for depreciation and amortization.
On the income statement, EBITDA is a line item above net income and some suggest that compared to net income, EBITDA paints a rawer image of profitability.
- Net Income or Profit: Typically, the last line on an income statement, net income refers to a company’s total earnings or profit. Simply put, net income is the difference calculated when subtracting all expenses (operating expenses, taxes, depreciation and withdrawals) from revenue. When a company’s net income increases, it’s normally a result of either revenue increasing or expenses being slashed. It goes without saying that an increase in net income is generally perceived as a positive thing!