Business Terms for Technologists

Skill

Feb 13

In general, folks with technical background, rightfully, focus solely on the technology aspect of the application or tool development, whereas business leaders are more concerned about the business value that can be generated by deploying the tool.

Bridge the Gap

Knowledge of commonly used business terms can help understand the business conversation and make sense of it. This also enables the technical team to appreciate the end goal, which is ultimately the value that your delivery will add to the business.

We will focus on some commonly used terms because gaining a basic understanding is essential for your growth as a leader to bridge the gap between IT and Business. The intent here is not to teach the intricate financial and mathematical details of each term, but rather the notion behind it.

Basic Concepts

ROI (Return on Investment): This is a commonly used term in daily life that tells you what you get for your investment.

Say, if you sponsor a project worth $1.0MM, will deploying it help reduce your operating cost and/or help grow revenue, and if so, by how much?
If the total value added is less than your investment, then it’s not worth it. You always want your return to be higher than your investment.

Cost: The amount needed to build a product or deliver a service is referred to as cost. For example:

For application development, the cost of the project includes labor & non-labor both. Non-labor expenses include licensing, hardware, software, travel, etc.
If you are selling this product or service to an external customer, then a slice of your operating expense will also become part of your cost.

Margin: Cost is the amount needed to build a product or service. To sustain a profitable business you will add a percentage amount to your cost, referred to as margin.

Cost and margin together is the price at which you want to sell your product or service to remain competitive.
Multiple factors are taken into account while determining margin. Some businesses like retail are inherently competitive and operate on very thin margins, while monopolistic businesses have the liberty to set their own targets (within legal and regulatory guidelines).

Price: This is the amount that combines your cost and margin.

You want to sell your product or service at this amount. Whether you are able to or not will make a difference in your overall earnings.
Selling at the desired price can be challenging and is driven by the present market condition.
If you are the only kid on the block with the product, you can set your own price. But in a multi-player market, you will always want to be at par or close to your competitors, unless you have a niche advantage.
Selling below your desired price does not mean that you have to reduce your margin. Instead, you can optimize or eliminate inefficient activities to manage your cost.

Profit & Loss: In simple terms, if you sell at anything above your cost, you will make a profit. If you sell under your cost you will have a loss. It’s not so simple, however:

At a product level, you might be profitable, but when you evaluate your entire portfolio, you still have to be profitable. One extremely bad product can wipe out the margin earned on all other products.
Another aspect is taxes, local compliance & regulatory fees and other expenses generally referred to as the cost of doing business.

Gross Income vs Net Income: Knowing the difference between gross and net can make or break the book. There is no room for misunderstanding here.

Gross income is total income. On an individual level, it’s the total earnings (salary, commissions, earned cash all-inclusive). For a business, it refers to total revenue less the cost of goods sold.
Net income takes into account all the expenses, taxes, and deductions as well. So your Net income is your take-home salary or for a business, it equates to profit, also referred to as net earnings.

Amortization & Depreciation:

Amortization is an accounting practice to write-off intangible company assets over a period of time, generally over its expected period of use.
Depreciation is an accounting practice to write-off tangible company assets over a period of time.

Commonly Used Terms

Revenue: Revenue is the income generated from normal business operations.

This is the money coming into the company by conducting its business activities. However, to run a business you will incur a lot of expense. Expenses will eat into your revenue.

Earning Before Interest and Taxes (EBIT): EBIT is the companies net income before including interest and tax payments. EBIT is an indicator of the profitability of the company. This is also referred to as Operating Earnings or Operating Profit.

This is not the same as Revenue.
EBIT includes all other costs except interest and taxes, whereas revenue is the total amount the business has brought in.

Earning Before Interest, Taxes, and Amortization (EBITA): EBITA is the company’s net income before interest, taxes, and amortization.

This is a measure used by investors as it reflects how much cash flow the company has to invest and pay dividends.
EBITDA is another measure also preferred by some investors, for precisely the same reasons as EBITA. In addition to excluding interest, taxes, amortization EBITDA also excludes depreciation.
EBITDA is more commonly used than EBITA, as it excludes depreciation as well.

Expenses: To set up and run a business you will incur expenses. It is essential to keep your expenses low while still be in a position to support company operations and growth. Expenses can be classified into Operating and Capital. The general rule of thumb is that if an item has a useful life of less than a year then it’s an operating expense. The accounting recognition of these expenses is important.

Operating Expenditure (OPEX): Expenses incurred to run your day to day business operations are classified as operating expenses, for example: phone & internet services, IT Support, Call Center etc. This is recorded in the Income statement and shows up as an expenditure.
Capital Expenditure (CAPEX): To expand and grow your business you will have to invest in it. This investment will enable the organization to generate value in the long run like acquiring new assets. This is recorded in the Balance sheet and shows up as investment.

Summary

The list above is by no means exhaustive, but familiarity with these terms will help you understand the value addition in the financial sense. You should be very comfortable with terms like EBITDA, Revenue, CAPEX, and OPEX as these are used frequently.

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