We have recently discussed how revenue should be recognized in a SaaS company. It is fairly straightforward. This article will discuss the difference between EBITDA vs. Gross Profit vs. Net Profit.
Investors often use metrics such as Operating Income, Net Income, and Free Cash Flow to help them decide which stocks are the best investments. Who can use these measures in many different ways depending on what market conditions are currently present?
There are three common metrics used to measure a SaaS company’s profit. EBITDA, Gross Margin, and Net Profit each tell you something different about the financial health of your business.
EBITDA
When evaluating a company’s financial health, analysts use metrics and ratios to measure profitability. The most common way of measuring this is through the standardized measures outlined in GAAP; however, some companies will also take non-GAAP approaches.
Another way to measure profitability is through EBITDA, which considers only the day-to-day expenses necessary for a company.
EBITDA is a way to measure the bottom line without considering other factors such as financing costs, accounting practices, and tax tables. Calculating EBITDA usually requires only an income statement or cash flow statement.
Why does EBITDA make sense for SaaS?
There are many ways to calculate EBITDA and Net Income. The best way is for companies that run their own infrastructure, as they can use operating income and free cash flow instead of net income because of equipment purchases or debt financing.
It turns out that 99% of SaaS companies use the cloud. Click To Tweet
EBITDA can be used to compare the profitability of companies. EBITDA removes financial and accounting decisions, so it provides a good way to analyze performance in an industry without these outside factors influencing results. For example, you could use EBIDTA as a percent of sales ratio when comparing efficiency within an industry.
EBITDA can be used to compare different types of companies because it removes the impact that interest and depreciation have on a company’s profitability.
How to calculate EBITDA
Operating profit, also called earnings before interest and tax (EBIT), is found on the income statement. Depreciation and amortization are typically in notes to operating profit or cash flow statements.
EBITDA is a company’s net profit that does not include accounting adjustments for depreciation and amortization.
Part of knowing the difference between EBITDA vs. Gross Profit vs. Net Profit is understanding how to calculate the EBITDA. The other method is to calculate EBITDA, which can be done by adding operating profit and interest expenses. However, this has the downside of being difficult to do.
One of the most popular metrics in business is EBITDA, which stands for Earnings Before Interest Taxes Depreciation and Amortization.
Be careful – The difference between them
EBITDA may be a widely accepted performance indicator, but it is not the only measure. EBITDA can provide an incomplete picture without considering other aspects of earnings and cash flow that could even lead to dangerous consequences.
Clearly, EBITDA does not take all of the aspects of business into account. Ignoring important cash items like depreciation and amortization, which are both necessary to keep a company running, overstates cash flow in an unreliable way.
Investors should not treat EBITDA as a substitute for cash flow because it does not provide complete information about its expenses. Click To Tweet
Investors can find out more by looking at the company’s Cash Flow Statement.
A company might be trading at a low multiple of EBITDA, but it doesn’t mean that the stock is inexpensive. Analysts will typically use earnings before interest and taxes (EBIT) as their metric for valuing stocks because they believe this number better reflects true profitability.
It’s important to note there are other metrics to gauge the value of a business. For example, some companies trade at a multiple of forecasted operating profits or estimated net income.
Gross Margin
The gross margin is the percentage of sales revenue that a company retains after direct costs. The higher this number, the more money is left to pay for other expenses.
The Gross Margin is calculated by subtracting the COGS from your Revenue. Therefore, the more expensive a product, the higher its margin.
Cost of Goods Sold
The cost of goods sold is a less straightforward topic when it comes to software. It refers to costs associated with delivering an application instead of inventory-based physical products. Wikipedia says that COGS “refers,” but there are conflicting reports online.
SaaS companies often include the following items in their COGS calculation:
- Hosting and web fees
- Customer service cost (like service rep salary)
- Customer onboarding (content, a customer success team, etc.)
In SaaS, credit card fees and other billing fees are not usually considered a cost of goods sold because they don’t add to the product price. Instead, these expenses fall under general administrative costs.
The difference between EBITDA vs. Gross Profit vs. Net Profit is the cost of goods sold. The cost of goods sold is an important metric to calculate gross margin because it considers the true costs associated with a company’s revenue, including software development and customer acquisition. However, this should not be confused with other expenses that are only incurred after making a sale.
COGS are easy to understand. It’s the costs that scale with the number of customers you have, so if you acquire 100 new customers next month and don’t plan on expanding your product team, then it will be necessary for some other department to handle all of these customers requests.
How to calculate Gross Margin
The calculation of the Gross Margin is a straightforward process.
The gross margin is the difference between revenue and the cost of goods sold.
Knowing the difference between EBITDA vs. Gross Profit vs. Net Profit is understanding how to calculate the gross margin. Gross margin is calculated as the percentage of revenue that remains after subtracting COGS. This value can be used to assess profitability, with software companies often having gross margins of 80-90%.
Gross Margin % is calculated by dividing Gross Margin by Revenue and multiplying the result to 100.
You can also use gross profit and gross margin to express your profits.
In some countries, such as Brazil, sales taxes are deducted directly from the revenue source. To account for this in your P&L statement, you should use Net Revenue (revenue after taxes).
The difference between Net Profit
When calculating net profit, you need to subtract its total expenses from its revenue. Net profit tells us how much money a company has earned or lost in a given period of time.
Net profit is a more accurate measure of profitability because it tells you the exact amount that makes up company profits. For example, a company’s revenue may increase, but not necessarily net income profitability if expenses have increased.
How to calculate Net Profit
Net profit is calculated by subtracting the cost of goods from revenue and dividing that number by gross sales. The net margin calculation would be as follows:
Knowing the difference between EBITDA vs. Gross Profit vs. Net Profit is understanding how to calculate the Net Profit. Net Profit is calculated by subtracting the Cost of Goods Sold, operating expenses, and other expenses from Revenue. In addition, interest paid on loan debt will also be subtracted.
The Net profit margin is the difference between your total revenue and your cost of goods sold. To calculate it, you divide net income by sales or revenue.
Net Profit Margin % is calculated by dividing Net Income (Net profit) by Revenue.
Conclusions – The Difference Between
When running a successful SaaS company, it can be difficult to know where you stand. However, comparing revenue growth and profitability can tell most of what needs to be assessed.
It is important to measure key metrics for a SaaS company. Still, they should be assessed differently depending on the stage of growth. Click To Tweet
In an early-stage company that has not yet reached operational efficiencies and achieved significant sales because profitability won’t come until later.
It is important to consider all of the different factors that make up your company’s profit. But it’s also important not to neglect these three metrics. First, make sure to know the difference between EBITDA vs. Gross Profit vs. Net Profit.
If you have any questions or concerns, please feel free to comment, and I will answer as soon as possible.
