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20 Most Confusing Finance Terms Understanding key financial terms is essential for making informed business decisions and evaluating company performance.
1. Fixed Costs vs Variable Costs Fixed Costs: - Costs that do not change with production volume.
Example: - Factory rent = $10,000/month → Remains constant whether 1 cable or 10,000 cables are produced.
Variable Costs: - Costs that vary based on production or sales volume.
Example: - Raw materials cost = $5 per cable → The more cables produced, the higher the total cost.
2. EBITDA vs Net Income EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): EBITDA = Revenue – Operating Expenses + Depreciation + Amortization Example: - Revenue = $1,000,000
- Operating Expenses = $400,000
- Depreciation = $100,000
- Amortization = $50,000
EBITDA = 1,000,000 – 400,000 + 100,000 + 50,000 = $750,000 Net Income: Net Income = EBITDA – Interest – Taxes Example: - Interest = $20,000
- Taxes = $100,000
Net Income = 750,000 – 20,000 – 100,000 = $630,000
3. Profit vs Revenue Revenue: - Total income from product and service sales.
Profit: Profit = Revenue – Expenses Example: - Sales = $500,000
- Expenses = $300,000
Profit = 500,000 – 300,000 = $200,000
4. CAPEX vs OPEX CAPEX (Capital Expenditures): - Funds used to acquire, upgrade, and maintain physical assets.
Example: - Buying new machinery for $50,000 → CAPEX
OPEX (Operating Expenses): - Day-to-day expenses to run the business.
Example: - Monthly electricity bill of $5,000 → OPEX
5. Accrual vs Cash Accounting Accrual Accounting: - Record revenue and expenses when they are incurred, regardless of payment.
Example: - A sale made in December but paid in January → Recorded in December.
Cash Accounting: - Record revenue and expenses when cash is exchanged.
Example: - A sale made in December but paid in January → Recorded in January.
6. Market Cap vs Enterprise Value Market Cap: Market Cap = Share Price × Total Shares Outstanding Example: - Share price = $50
- Shares = 1,000,000
Market Cap = $50 × 1,000,000 = $50,000,000 Enterprise Value: Enterprise Value = Market Cap + Debt – Cash Example: - Debt = $10,000,000
- Cash = $5,000,000
Enterprise Value = $50,000,000 + $10,000,000 – $5,000,000 = $55,000,000
7. Assets vs Liabilities Assets: - All resources owned and controlled by a company.
Example: - Factory = $1,000,000
- Machinery = $500,000
Liabilities: - All obligations a company owes to others.
Example: - Bank loan = $200,000
8. Gross Margin vs Net Margin Gross Margin: Gross Margin = (Gross Profit ÷ Revenue) × 100 Example: - Gross Profit = $400,000
- Revenue = $1,000,000
Gross Margin = ($400,000 ÷ $1,000,000) × 100 = 40% Net Margin: Net Margin = (Net Income ÷ Revenue) × 100 Example: - Net Income = $200,000
- Revenue = $1,000,000
Net Margin = ($200,000 ÷ $1,000,000) × 100 = 20%
9. Return on Investment (ROI) vs Return on Equity (ROE) ROI: ROI = (Net Profit ÷ Total Investment) × 100 Example: - Net Profit = $50,000
- Investment = $500,000
ROI = ($50,000 ÷ $500,000) × 100 = 10% ROE: ROE = (Net Profit ÷ Shareholder's Equity) × 100 Example: - Shareholder's Equity = $200,000
ROE = ($50,000 ÷ $200,000) × 100 = 25%
10. Financial Leverage vs Operating Leverage Financial Leverage: - Use of debt in capital structure to amplify returns.
Example: - A factory takes a $1,000,000 loan at 5% interest to finance new equipment.
Operating Leverage: - Use of fixed vs. variable costs to amplify operating income.
Example: - Increasing fixed costs (e.g., factory rent) vs reducing variable costs (e.g., labor).
✅ Summary Example (Cable Factory): | Term | Example | Result |
| Market Cap | Share price × Total shares | 50,000,000 |
| Net Margin | Net Income ÷ Revenue | 20% |
| ROI | Net Profit ÷ Investment | 10% |
| CAPEX | New machine purchase | 50,000 |
Practical Insights: - Understanding EBITDA vs Net Income prevents misjudging profitability.
- Knowing Fixed vs Variable Costs helps in cost control and forecasting.
- ROI and ROE give insight into investment and shareholder returns.
- Accrual vs Cash Accounting affects cash flow visibility.