In this article, we will describe and explain some of the terms most commonly used during discussions of financial performance and business meetings. Understanding what these terms means is essential if you are a new or potential Corporate Finance professional such as a Financial Analyst in the FP&A department, or even a new Accounting and Finance professional. It helps significantly in the job interview process as well if you are interviewing for a job in such Finance roles as you are expected to know what they mean and demonstrate experience of their use.
Would you like to work with me to get one on one training, or to solve your specific workplace challenges, book your 15 minute consultation here: https://calendly.com/learnaf
The key financial and business terms we will discuss in this article are as follows:
- MTD, QTD, YTD
- Plan, Budget, Forecast, LE
- Gross Profit, Net Profit, EBIT and EBITDA
- Variance, Favorable and unfavorable variance
- YoY, vs LY, vs Bud
MTD – represents Month to Date. The ‘To date’ captions are usually used to represent financial performance or activities for a period of time. MTD will always be followed by the name of a month e.g. “MTD August” means results or performance from the start of August (i.e. 1st August) to the current date of the month of August. However, MTD is more commonly used to refer to the entire month, and can also be used to refer to a month that has already finished. For example, if you are currently in the month of August, then ‘MTD April’ will represent the financial performance for the entire month of April.
QTD – represents Quarter to Date. QTD represents the performance from the start of the Quarter to the current date. E.g. if the company’s financial or fiscal year runs from January to December, and you are looking at the performance of Q4 (ie October to December), QTD would represent performance for the period starting from October 1st to the current date. If the current date is December 15th, then QTD will represent the period from Oct 1st to Dec 15th (roughly 2.5 months).
YTD – represents Year to Date. This term refers to the financial performance, KPIs or activities from the the start of the year to the current date. Again, most commonly, this term is used to refer to the period from the start of year to the end of the most recent month. Similar to MTD, YTD is also followed by month. So, for example, “YTD March” refers to the results related to the period starting from the 1st of January and finishing on March 31st. It is important to remember that the fiscal year or reporting year of some companies may not be the standard January to December period. For example, for a company, the financial reporting year may start from July and end in June of the next year. In this case, the YTD period will start from July, and in this case, YTD September will only reflect the performance for the three months period from July to September.
Note: If you would like to learn in detail, how to calculate sales variances and the impact they have on sales $, profit $ and profit margin %, and how to explain performance vs budget and prior periods, click here for a detailed video course (at a special price for readers of this post) showing exactly how this is done. You will also learn how to analyse and present the results of the variances to management and will be able to download solved variance calculation Excel templates.
Plan or Budget – Most companies have an annual budget cycle, where well before the start of the year, an extensive and thorough exercise is conducted to plan and quantify the expected (or desired) financial results of the next year. The final outcome of the exercise is called “Budget” or “Plan”, and is represented in the form of budgeted income statement, budgeted balance sheet, and often a budgeted cash flow statement. However, a lot of detail may be available as back up to the numbers reflected in these budgeted financial statements. For budgeted income statement, it is common to start with YTD actual performance of the current year, and then add forecast for the rest of year. The full year forecast (including YTD actual numbers) for the current year then becomes the basis for the next year budget. Budgeted balance sheet and budgeted cash flow statements follow the budgeted income statement with additional assumptions for the budget year.
Forecast – The budget or plan is prepared usually once a year. However, things change quickly, therefore many organizations have forecasts in place as well. A forecast is an estimate of the financial performance, but is typically less extensive and thorough when compared with the budget exercise. The frequency of forecasting also varies. Some companies revise forecasts every month, while others may revise them every quarter or even every six months. It is important to note that while forecasts are revised frequently, the budget remains the same. Therefore, when comparing actual results, often the comparison is done both against the Plan (Budget) as well as the current forecast. This is because budget is not rendered completely irrelevant as a result of the availability of a Forecast. Some bonuses and commissions might still be linked to the original budget, and therefore keeping an eye on the performance vs budget is important.
LE – represents Latest Estimate. This term is used to define the most recently communicated or approved estimate of financial performance, specially related to sales. It is similar to a “forecast”, but different in that a forecast is usually submitted at the start of a quarter or a month, but latest estimate can be provided in the middle of a month or quarter as well. A typical example would be, for example at the start of the month of January, a sales forecast is submitted, lets say of $100,000 for the month. However, every Monday, the forecast is reviewed, and then based on new information, the forecast for the month is revised. Lets say, on the 15th of January, based on actual sales so far and information provided from Sales team, it now appears that sales for the month of January by the end of the month will be $120,000. This will be presented in the form of Latest Estimate (LE). So the forecast is still $100,000, but the latest estimate is now $120,000. Usually, a separate column is used to reflect latest estimate next to budget, forecast or prior year actual numbers.
Note: Not all organizations use Latest estimate, and often the term Forecast is used interchangeably with latest estimate.
Gross Profit – Gross Profit can be calculated with the following formula:
Gross Profit = Revenue – Cost of goods/services sold
where revenue represents the proceeds from the sale of products or services, and Cost of goods/services sold represents the cost of producing or procuring the goods, or in the case service, the cost of rendering the service related to the revenue earned.
What is important is that for the calculation of gross profit, other expenses required to operate the business (also known as Operating expenses) are not deducted from revenue. Gross profit only looks at the profit when considering costs of product or service, and not the operating costs of business. Here is a video I created explaining Gross profit, and the difference between Gross profit and Net profit in more detail…
Net Profit – Net Profit considers all the costs including cost of operating business such as selling, general and admin costs including taxes and interests etc. So, Net profit can be calculated with the formula below:
Net Profit = Gross Profit – Operating costs – interest and taxes
or Net Profit = Revenue – Cost of goods/services sold – Operating costs – interest and taxes
Net profit is also referred to as the bottom line, as this is literally found at the bottom of the income statement, and also reflects the overall net profitability of the business.
FYI: Revenue is often referred to as “Top line” as most income statements start with Revenue at the top.
EBIT – represents Earnings Before Interest and Tax, and is a very commonly used measure of the financial performance EBIT reflects the net profit or net income of a business excluding a) interest and b) tax expense, and can be represented with the formula:
EBIT = Net Profit plus (Interest and Tax expense)
What is the importance or use of EBIT? EBIT simply shows you the operational performance of a business before considering interest and tax expense. Think of it this way … if you are an investor looking to invest in a company, you are interested in knowing the EBIT from operations of a company because the interest and tax expenses may not remain the same when you buy the business. You may have extra cash available and might not need the same level of borrowing as the existing business, or the taxation rules that apply to you may be completely different. By looking at EBIT, you can tell exactly what a business can make from its operations on its own before factors such as interest and tax are taken into account.
EBITDA – represents Earnings Before Interest, Tax, Depreciation and Amortization. In calculating EBITDA, we remove depreciation and amortization expenses in addition to interest and tax expenses. Depreciation and amortization are often referred to as ‘non-cash’ expenses. This is because, the actual outlay of cash has often already taken place in the past. Depreciation is a systematic allocation of the cost of fixed assets over the useful life of the asset. So, for example, if a building is purchased at the cost of $1 million, and the useful life of the building is determined to be 25 years. Although the total cost of purchase ($1 million) may have been paid in year 1, a portion of the cost will be recorded in the income statement every year till the completion of the 25 years. Similarly, amortization is the allocation of cost of intangible periods over a pre-defined period of time.
Why is EBITDA important? When looking at the net profitability of a business, depreciation and amortization create two problems; 1) timing difference between the actual cash flow and the recording of expense in the income statement (as in the example above), and 2) different companies my use different methods or assumptions when calculating depreciation and amortization. As a result of these problems, it is often a good idea to take a look at EBITDA, specially when comparing two or more companies for their operational performance. EBITDA helps you compare the performance of companies by excluding the impact of financial, accounting and taxation decisions.
YOY – represents Year over Year. This usually represents a comparison of prior year to current year. You will hear the phrase ‘Year over year growth’ or ‘year over year decline’. A YoY growth of 2% in sales e.g, represents that sales have increased by 2% vs last year. The formula for this will be:
YoY Sales Growth = (Current year Sale – Prior year sale ) / Prior Year Sale
However, the calculation does not need to be for the entire 12 months period. You can also have YoY growth or decline for a period of three months, six months or any number of months or days. For example, you may compare the sales of January to March period of last year with the same period (January to March) of the current year. The key is to compare the same number of months, when doing this comparison.
Variance – Variance simply represents difference. It can represent difference from target, difference of previous performance, difference from estimate or expectation and difference from budget.
Unfavorable Variance – For example, if the target for a sales representative for a month was to make a 100 sales of a given product. but the actual sales he or she made in that month turned out to be 90, the variance in this case is -10. It is denoted by a minus or negative sign because it is an unfavorable variance. This is because the more a sales representative can sell, the better it is for the company as well as the sales representative. Therefore, selling less than target is an unfavorable variance and is a negative situation denoted by a negative sign.
Favorable Variance – If, however the actual sales were 105 units, this would be a favorable situation and the variance would be represented by a positive sign, being +5 units.
Note that the higher the sales or income vs target, the more favorable the variance is. However, the higher the expenses are vs target the more unfavorable the variance, as expenses have an unfavorable impact on the profitability of a company.
vs LY and vs Bud – vs LY represents Versus Last Year (often also referred to as versus prior year), and vs Bud represents Versus Budget. Both of these terms are used to compare against actual current year performance. So, for example, vs LY would represent the difference between actual results this year, and the results for the same period last year. Similarly, vs Bud will represent the difference between actual results this year, and the amount budgeted for the current year. As an example, if actual revenue for current year was $10,000, budgeted revenue for current year was $12,000 and revenue from last year was $7,000. Then, in this case variance vs last year is +$3,000 (because actual sales in the current year are higher) and variance vs budget is -$2,000 (because actual sales in the current year are below the budgeted amount).
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