Why a Difference of $23,540,543 Means Absolutely Nothing

Revenues are not always the best measure of company performance. Look at these five numbers instead.

Of all of the measures of business success, revenue seems to be the one that people always ask about and the one that people brag about most. Many networking organizations, for example, use revenue as a bar for entry. Even the Inc. 500/5000 uses revenue to calculate growth.

That said, revenues can often be misleading. Hitting a high bar on revenue doesn't mean you're truly bigger, better or faster than a company in a lower revenue bracket.

It's an important number to know, yes. It's also just one of several key numbers that describe the size--and more importantly the health and profitability--of a business.

Allow me to illustrate. I have one client who has around $29 million in annual revenues. However, they also have almost $22 million in direct expense for materials and equipment, which they basically purchase and resell directly to their customers.

When you calculate their gross profit, it's only about $7 million. Sales, overhead, and management expenses come to just over $5 million. This leaves $2 million in profit and a profit percentage of roughly seven percent.

Compare this to another client who has around $5 million in annual revenues. While much lower than the previous client, they only have just under $1 million of direct expenses for the products and services they sell to their clients.

They also have around $2.5 million in sales, overhead and management expenses. This leaves them with an impressive $1.5 million in profit and a profit percentage of almost 30 percent.

The first client has a significant amount of revenue. But when you look at the operational performance and final profit of the business, client number two is a much more attractive company from an investment point of view.

Here are five things to look at beyond top-line revenue. This might get a little wordy--but knowing what these mean and how to calculate them is important if you truly want to accurately measure success.

1. Costs of good sold (COGS)

Many people forget about this important number. It tells you how much you have to spend to generate incremental revenue.

When you sell a product or project, or when you provide a service, COGS is the money you spend to provide that additional unit. For products, it's the raw materials or the wholesale price. For services, it might be the cost of additional freelancers or part time staff.

This figure does not include your full-time staff and expenses, which you pay for regardless of the sale.

2. Gross Profit

This is your profit after you account for your COGS. To calculate your gross profit, take your revenue and subtract your COGS. It shows how much profit you're generating against your core business costs.

For some companies, the COGS are very high leaving a very low gross profit. If you're a supermarket, for example, between 50-75 percent of your revenue will be COGS. If you're someone like Costco, your COGS will be between 85-90 percent of your revenue, leaving just 10-15 percent gross profit.

3. Overhead Expenses

Overhead is everything that isn't COGS, debt payments or amortization (capital investment charges). This includes things like management salaries, staff salaries, equipment, space, utilities, etc.

It also includes your general sales and marketing salaries and expenses. If you're doing detailed analysis, you can put these in different categories and see what's happening over time.

One of the key analysis of company performance is the difference in COGS and overhead expenses--especially once you start hiring full-time staff or investing in processes and equipment that can reduce COGS but increase risk if sales vary or start to lag.

4. EBITA

You often hear this term thrown around when listening to investment wonks talking about valuations. EBITA is a not a Spanish party island in the Mediterranean (though sometimes I wish). It's your profit, or earnings, before you account for interest, taxes and amortization.

For companies that don't have large capital investment requirements for inventory and the like, consider the EBITA an effective profit figure of the company. If your company has large inventories or investments in capital expenses--such as equipment--you'll need to factor those in to calculate your effective profit.

5. Net Profit

This is what's left after we pay debt obligations, calculate amortization and account for interest and taxes. It's basically the increase (or decrease in some cases) to the cash position of the company.

If you're growing your business, you'll need to make sure this number is positive--and, ideally, growing--to support the additional investments needed for scaling the company.

By getting a handle on these key financial metrics and seeing what has been happening with them over time, you'll have a much better idea of the current and likely future value of the business. You'll also be in a much better position to evaluate the performance of your company and your investment's risk and return.

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