Many new businesses fail to turn a profit in the first few months or years, but still attract the attention of investors. This is because experienced investors typically look at indicators other than net profit to evaluate a company’s potential for future success. Here’s a look at a few of the metrics investors may consider before deciding whether or not to make on offer.
Gross Profit is a company's sales revenue minus the cost of goods sold. This figure takes into account the variable costs associated with making a product, but excludes selling and administrative costs. Gross profit margin, or gross profit as a percentage of sales, is sometimes used by investors to analyze pricing of a company's product. If the cost of producing a product is too high compared to the price customers are willing to pay, then the company may not earn enough to cover future expansion.
Positive cash flow does not necessarily translate into profit, but it's an important sign of a company's overall health. A company that is pulling in cash may be freer to invest in the future of their business without being weighed down by day-to-day survival concerns. Investors may look at a company’s EBITDA margin — earnings before interest, taxes, depreciation, and amortization as a percentage of total revenue — for a rough calculation of a company's cash flow in any given period.
Operating profit is important to investors because it shows that a company is able to make money from its core product or service. To calculate this number, the cost of goods sold is combined with operating and depreciation expenses and then subtracted from operating revenue. Operating profit does not take investment income, interest expenses, or taxes into consideration.
Income taxes usually affect a company’s net income. Different states and municipalities apply different tax rates, so pre-tax income is one way of normalizing these variances when comparing companies. Looking at pre-tax income is also helpful because taxes in one period could be affected by events that occurred in earlier periods.
Net profit is a company's bottom line, or the amount of money made in a certain period according to the income statement. Net profit includes items such as depreciation, amortization, and tax expense. Profit margins, or net profits as a percentage of sales, can be compared to other companies in an industry to determine how well a company turns revenues or sales into profits.
Management reporting — a capability usually found in online accounting systems — allows businesses to analyze net profits and identify income and expense trends. Management reports can also be broken out by product or service to highlight which areas of the company are performing better than average. Often, management will have their own preferred way of analyzing profits, and can design their own reports to meet their needs.
Many nascent companies incur significant costs that affect short-term profits, but experienced investors understand what it takes to get a company going. They will often examine financials for signs of long-term growth rather than simply looking for immediate profitability. When seeking outside investment or debt financing, companies should be able to explain why their profits are what they are and also have a clear plan for future growth.