Don't fall into the 'busy fool' trap. The busy fool is someone who's running a business, and literally running themselves into the ground, without a net profit coming out at the end. It's so easy to become a busy fool, fighting fires in your business all day, without visibility on what is generating revenue and, critically, net profit. The Pareto Principle often applies; most things can be broken into an 80:20 ratio. In business, 80% of profit usually comes from 20% of customers, for example. Understanding where to apply your limited energy is a gamechanger. And you'll stop being a busy fool.
Introduction by Gary Byrnes, founder of MarginGlow.
A note on 80:20: The Pareto Principle is a useful rule of thumb, not a guaranteed split. Check your own customer and product profitability to see where your effort pays off.
You can be brilliant at your work and still find business language unnecessarily confusing. This guide explains 24 useful terms with small examples, simple formulas and the mistakes to watch for.
Start with the first six if you are short of time. They explain the journey from making a sale to making a profit. Then read cash flow before deciding that profit is yours to spend.
Examples are fictional and use euros, but the arithmetic works in any currency. Sales figures exclude VAT or sales tax collected on behalf of tax authorities. The examples simplify accounting; classifications and tax treatment depend on your business and jurisdiction.
Start here: where did the money go?
Imagine a small shop with these figures for one month:
| Step | Amount | What it means |
|---|---|---|
| Sales revenue | €10,000 | Sales earned after discounts and returns. |
| Less cost of goods sold | €4,000 | The cost of the products sold that month. |
| Gross profit | €6,000 | What remains to cover the rest of the business. |
| Less operating expenses | €4,500 | Rent, staff, software and other operating expenses, including depreciation where applicable. |
| Operating profit | €1,500 | Profit from operations before financing and income tax in this example. |
| Less interest expense | €100 | The cost of borrowing. |
| Profit before tax | €1,400 | Profit before the example company's income tax expense. |
| Less income tax expense | €200 | An illustrative figure, not a tax-rate calculation. |
| Net profit after tax | €1,200 | Profit after all expenses shown above. |
The shop has a 60% gross profit margin and a 12% net profit margin. Neither figure tells us its bank balance. Some customers may not have paid yet, and some cash may have gone into stock or loan repayments.
For background on how income statements, balance sheets and cash flow statements relate, see the SEC's beginner's guide to financial statements.
Making money and understanding profit
1. Revenue, sales and turnover
Revenue is the income a business earns from its ordinary activities before deducting its business expenses. In a typical small business, sales and turnover often describe the same sales total.
Example: You sell 100 products for €50 each. With no returns or discounts, sales revenue is €5,000.
Watch for: A bank loan is cash coming in, but it is not revenue. An unpaid sale can be revenue under accrual accounting even before the customer pays.
2. Cost of goods sold, or cost of sales
Cost of goods sold is the cost assigned to the products you sold during the period. Service businesses may use “cost of sales” for directly attributable delivery costs.
Example: A shop sells 100 mugs that cost it €8 each to buy. Their cost of goods sold is €800, even if the shop purchased another 200 mugs that remain on its shelves.
Watch for: Stock purchases and cost of goods sold are not automatically the same number. For services, agree a consistent treatment of delivery labour and other direct costs with your accountant.
3. Gross profit
Gross profit is revenue minus cost of sales, before deducting the remaining operating expenses.
Formula: Gross profit = revenue − cost of sales.
Example: €10,000 revenue minus €4,000 cost of sales leaves €6,000 gross profit.
Why it matters: This is what is available to pay the rest of your costs. A healthy-looking sales figure can hide products that leave very little behind.
4. Operating profit
Operating profit is the profit from running the business after operating costs, before interest and income tax in a straightforward business.
Example: €6,000 gross profit minus €4,500 operating expenses leaves €1,500 operating profit.
Watch for: Do not deduct an expense twice. If delivery labour is already included in cost of sales, it must not be deducted again as an operating expense.
5. Net profit
Net profit is the amount left after the expenses included in the reported profit measure have been deducted from income. In this guide, “net profit” means net profit after all expenses, including interest and the company's income tax expense.
Example: Our shop earns €10,000 in revenue and incurs €8,800 in total expenses. Net profit after tax is €1,200.
Watch for: Some small-business reports use “net profit” for a pre-tax figure. Check the label. A sole trader's personal income tax is generally separate from the business profit calculation. Net profit is also not automatically the owner's take-home pay or spendable cash.
6. Profit margin
Profit margin expresses a particular profit figure as a percentage of revenue. Always name the type: gross, operating or net.
Formula: Profit margin = profit ÷ revenue × 100.
Example: €1,200 net profit ÷ €10,000 revenue × 100 = 12% net profit margin. Each €1 of sales leaves 12 cents of net profit in this example.
Watch for: “We make a 60% margin” is incomplete unless you know which costs have been deducted.
Pricing work without accidentally giving it away
7. Markup
Markup is the amount added to a cost to set a selling price, expressed as a percentage of that cost.
Formula: Markup = (selling price − cost) ÷ cost × 100.
Example: Buy for €60 and sell for €100. The markup is €40 ÷ €60 = 66.7%. The margin on the selling price is €40 ÷ €100 = 40%.
Watch for: A 40% markup does not give you a 40% margin. That small vocabulary mix-up can become an expensive pricing policy.
8. Fixed costs
Fixed costs do not change directly with sales volume within a particular period and capacity range.
Example: A €1,500 monthly lease usually remains €1,500 whether you serve 100 or 150 customers.
Watch for: Fixed does not mean permanent. Costs can rise when a lease renews or you need bigger premises.
9. Variable costs
Variable costs change with the amount you produce, sell or deliver.
Example: Each order uses €3 of packaging and incurs a €1 transaction fee. Another 100 orders add €400 of those costs.
Watch for: Some costs are mixed. An electricity bill may contain both a fixed standing charge and usage charges. Variable cost and cost of sales are different classifications, not interchangeable labels.
10. Contribution margin
Contribution margin is sales revenue minus variable costs. It can be stated as an amount or percentage. It shows what is available to cover fixed costs and then generate profit.
Example: A service sells for €80 and has €30 of variable delivery costs. Its contribution per appointment is €50. Its contribution margin ratio is 62.5%.
Why it matters: A discount comes out of that contribution. Reducing the price to €70 leaves €40, a 20% reduction in contribution despite a 12.5% price cut.
11. Break-even point
Break-even is the sales level at which the costs included in your calculation are covered and profit is zero.
Formula: Break-even units = fixed costs ÷ contribution per unit.
Example: With €3,000 monthly fixed costs and €50 contribution per appointment, you need 60 appointments to break even. At 61 appointments, the extra €50 becomes profit within this simplified model.
Watch for: Include a realistic cost for your work when deciding whether the business supports you. A calculation that assumes the owner works for nothing answers the wrong question.
Having money when the bills arrive
12. Cash flow
Cash flow is the movement of money into and out of the business over a period. Net cash flow is the difference between those inflows and outflows.
Example: Customers pay €8,000 this month and the business pays out €9,000. Net cash flow is negative €1,000.
Watch for: You can show a profit and still run short of cash. Customers can owe you money while your landlord expects payment today. A new loan can improve cash flow without improving profit.
13. Accounts receivable, or trade debtors
Accounts receivable is money customers owe for sales already made on credit.
Example: You complete and invoice a €2,000 job with payment due in 30 days. Until paid, that invoice is a receivable.
Useful next step: Check which invoices are overdue, rather than looking only at the total owed. A receivable that never gets paid cannot fund your next wage bill.
14. Accounts payable, or trade creditors
Accounts payable is money the business owes suppliers for goods or services already received on credit.
Example: You receive €600 of supplies with payment due next month. That €600 is a payable until settled.
Watch for: A healthy bank balance can look less healthy once upcoming supplier payments are included.
15. Working capital
Working capital is current assets minus current liabilities. It includes short-term resources and obligations, not just cash.
Example: €5,000 cash, €4,000 receivables and €3,000 stock give €12,000 of current assets. Subtract €7,000 of current liabilities and working capital is €5,000.
Watch for: Slow-selling stock and overdue invoices do not pay bills as easily as cash. A positive number is useful, but timing and collectability still matter. See BDC's working capital explanation.
16. Cash runway
Cash runway estimates how long available cash will last if the business continues using cash at its current net rate.
Formula: Runway in months = available cash ÷ monthly net cash burn.
Example: €12,000 of available cash and average net cash outflow of €3,000 per month give roughly four months of runway.
Watch for: This simple formula is for a cash-burning business. Seasonal changes, taxes and one-off payments can shorten the real runway. Use a dated cash forecast for decisions.
Reading the accounts
17. Profit and loss statement, or P&L
A P&L reports income, expenses and profit or loss over a period. It is also called an income statement.
Example: A September P&L shows how the business performed during September. It does not show how much cash is available today.
Useful next step: Compare several months using consistent categories. Look for costs increasing faster than sales.
18. Balance sheet
A balance sheet shows assets, liabilities and owners' equity at a particular date.
Example: A business reports €30,000 of assets and €18,000 of liabilities. Its book equity is €12,000.
Watch for: It is a snapshot. It does not tell you the business's sale price or replace a cash forecast.
19. Assets
Assets are economic resources the business controls that are expected to provide future benefit. Examples include cash, receivables, stock and equipment.
Example: A work van can be an asset even if you financed its purchase with a loan. The van and the loan appear separately in the accounts.
Watch for: An asset's accounting value is not necessarily what a buyer would pay for it today.
20. Liabilities
Liabilities are obligations the business owes to others. They include loans, unpaid supplier bills and certain tax or customer obligations.
Example: A €10,000 bank loan is a liability. Receiving it increases cash but does not make the business €10,000 more profitable.
Watch for: Repaying loan principal reduces cash and the loan balance. It is not the same as an interest expense in the P&L.
Finding customers profitably
21. Conversion rate
Conversion rate is the percentage of a defined group that completes a chosen action. That action might be an enquiry, booking or purchase.
Formula: Conversion rate = conversions ÷ relevant opportunities × 100.
Example: Twenty bookings from 500 website sessions give a session-to-booking conversion rate of 4%.
Watch for: State the denominator and the action. A visitor-to-enquiry rate and an enquiry-to-sale rate describe different parts of the journey.
22. Customer acquisition cost, or CAC
CAC estimates how much you spend on sales and marketing to acquire one new customer.
Formula: CAC = relevant acquisition costs ÷ new customers acquired.
Example: €1,000 of campaign, agency and sales costs produces 20 new customers. CAC is €50 per customer.
Watch for: Match costs and customers sensibly across the buying cycle. Counting only advertising spend can understate the cost. A €50 customer acquisition cost needs more than €50 of sales to be profitable once delivery costs are considered.
23. Return on investment, or ROI
ROI compares the net benefit of an investment with its cost. Define the benefit and time period before calculating it.
Formula: ROI = (financial benefit before investment cost − investment cost) ÷ investment cost × 100.
Example: A €500 improvement produces €800 of additional contribution after delivery costs over six months. Its net benefit is €300 and ROI is 60% over that period.
Watch for: Additional sales are not automatically additional profit. Include implementation time and ongoing costs where relevant.
24. Return on ad spend, or ROAS
ROAS compares revenue attributed to advertising with the amount spent on those ads.
Formula: ROAS = attributed revenue ÷ advertising spend.
Example: €1,000 of attributed sales from €250 of ad spend gives 4× ROAS.
Watch for: A 4× ROAS does not mean four times your money in profit. If those sales generate €200 of contribution before advertising, the €250 ad bill leaves a €50 loss before fixed costs. Attribution can also differ between advertising platforms and your own records.
Three questions business owners ask
Is net profit the money in my bank account?
No. Net profit describes accounting performance over a period. Your bank balance also reflects when customers pay, purchases of assets and stock, borrowing, repayments and money taken out by owners.
What is a good net profit margin for a small business?
There is no single percentage that suits every business. Compare similar businesses using the same definition, and check whether owner pay is included. A margin achieved by leaving your own labour unpaid can give a misleading picture of commercial health.
Which numbers should I understand first?
Start with revenue, cost of sales, gross profit, net profit and cash flow. Then use contribution and break-even to understand pricing, and conversion rate and acquisition cost to understand growth. You do not need to memorise the entire glossary before doing something useful.
Turn the words into a better business decision
Pick one product, service or month. Write down its revenue, the relevant costs and what remains. Then ask which assumption you have not checked.
If you want help finding practical opportunities in your business, start a free MarginGlow Business Check-up. It is a starting point for identifying opportunities, not a replacement for your accounts or accountant.
For your next step, explore getting found on Google or using AI in your business.