Business finance terms can be overwhelming, even for seasoned sellers. How do you keep your CAC, COGS, and CapEx straight without losing your (over)head?
The good news is, you don’t need to be a financial expert to make sense of it all.
In this straightforward guide, we’ll cover the key business finance terms for e-commerce, including the need-to-know metrics you need to succeed.
Business Finance Terms for E-commerce Quick Reference
| Term | Definition |
|---|---|
| Acid Test Ratio | Determines whether or not a company can easily cover its short-term expenses with current liquid assets. |
| Average Order Value | The amount an average customer spends on an individual transaction. |
| Balance Sheet | Financial statement listing a company’s assets, liabilities, and shareholder equity. |
| Bounce Rate | The ratio of visitors to a company’s website who never make it past the first page. |
| Capital Expenditures | Funds a business spends on acquiring, maintaining, and upgrading its fixed and/or physical assets. |
| Cash Conversion Cycle | The amount of time it takes a business to turn its inventory into cash. |
| Cash Flow | The amount of money that moves in and out of a business over a given period of time. |
| Contribution Margin | Money generated by sale of a given product, after subtracting variable production costs. |
| Cost of Goods Sold | Direct costs associated with producing products a business sells. |
| Credit Score | A measure of how likely a business is to pay borrowed funds back, on time. |
| Current Assets | All the resources company could convert to cash within one year or one operating cycle. |
| Customer Acquisition Cost | The total cost of persuading a potential customer to buy your product or service. |
| Customer Lifetime Value | The total revenue a customer contributes to a business over the duration of their relationship with that business. |
| Debt-to-Equity Ratio | A measure of a company’s total debt relative to its shareholder equity. |
| Depreciation | An accounting method of spreading the cost of an asset out over its lifetime. |
| EBITDA | Earnings before interest, taxes, depreciation, and amortization. A figure that helps measure a company’s core profitability. |
| Economies of Scale | When a company increases efficiency and lowers costs by producing more of the same item. |
| Economies of Scope | When a company increases efficiency and lowers costs by producing a greater variety of items. |
| Fixed Costs | Expenses that aren’t impacted by how much a company produces. Also known as overheads. |
| Leveraged Buyout | When one company purchases another primarily using borrowed funds. |
| Liabilities | Any debts a business owes. |
| Marginal Cost | An increase or decrease in production costs when a business produces one more unit or serves one more customer. |
| Market Liquidity | How quickly or easily large assets can be bought or sold, as well as the stability of pricing. |
| Merchant Cash Advance | A lump sum cash advance with a flat fee. |
| Net Operating Income | A company’s direct profit, after direct operating expenses are subtracted from income. |
| Overhead Costs | All of the expenses a business incurs, excluding direct production costs like materials and labor. |
| Profit | Money generated by a business when its total revenue is higher than its total costs. |
| Profit Margin | A ratio for measuring the amount of profit a company makes. |
| Return on Investment | A measure of how profitable a given investment is for a business, relative to its cost. |
| Revenue | The total amount of money a business generates through its normal operations. |
| Revenue-Based Financing | A financing structure where a business repays its lenders or investors by disbursing a certain percentage of its revenues. |
| Valuation | The process of determining the worth of a company, investment, or asset. |
| Working Capital | The amount of cash a business has on hand for its day to day operations |
Acid Test Ratio
Acid test ratio, also known as quick ratio, is a simple measure of a company’s liquidity. It determines whether or not a company is in a good position to cover its short-term expenses with current liquid assets, typically within the next 90 days, without selling off inventory or other assets.
To calculate the acid test ratio, use the following formula:
Acid Test Ratio = Short-Term Assets / Current Liabilities
Or you can break it down further using the following formula:
Acid Test Ratio = (Cash & Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
The acid test ratio is a quick way to measure a company’s financial health. In the simplest terms, it tells you whether you have enough cash on hand. For most industries, an acid test ratio of 1 or higher is considered good.
Average Order Value
Average Order Value (AOV) tells you how much your customer spends on average during each individual transaction, over a given period of time.
To calculate AOV, use the following formula:
Average Order Value = Revenue / Number of Orders
A low AOV indicates you might not be doing enough to maximize sales potential with your current customer base.
To increase your AOV, try product bundles, promotional offers, or upselling and cross-selling, especially at checkout. You can also offer free shipping with a minimum order amount, start a customer loyalty program, or use live chat to offer support and make complementary product recommendations.
Balance Sheet
A balance sheet is a financial statement that lists a company’s assets, liabilities, and shareholder equity. It provides a broad overview of a company’s current and overall financial health, and is a useful tool for predicting future cash flow and growth potential.
As an e-commerce business owner, you may also share your balance sheet with current or potential investors, so they can take the pulse of your company’s finances. Banks and other lenders may use your balance sheet to make loan determinations.
Bounce Rate
A bounce rate is the ratio of visitors to a company’s website who never make it past the first page. A high bounce rate means a lot of customers are visiting your site without buying anything.
To calculate bounce rate, use the following formula:
Bounce Rate = Single-Page Sessions / Total Site Visits
A high bounce-rate could mean many different things about your site or e-commrce business. It could indicate your page is slow to load, and customers get impatient and click away. It could also mean you need to improve your user experience, optimizing for better readability or targeting potential customers with personalized landing pages.
Capital Expenditures
Capital expenditures (CapEx) are all the funds a business spends on acquiring, maintaining, and upgrading its fixed and/or physical assets. These include things like factory equipment, computers, software, furniture, real estate, and other assets expected to remain with the company for at least the next fiscal year. These assets are also known as PP&E, which stands for Property, Plant, and Equipment.
To calculate CapEx, use the following formula:
Capital Expenditures = PP&E (Current Period) – PP&E (Prior Period) + Depreciation (Current Period)
E-commerce businesses can use their CapEx to determine whether they’re making good long-term purchasing decisions and investments in the future of their business.
Cash Conversion Cycle
A cash conversion cycle (CCC) is the amount of time, in days, it takes a business to turn its inventory investments into cash. To calculate it, you first need to understand a few other metrics: your Days Inventory Outstanding (DIO), Days Sales Outstanding (DIO), and Days Payable Outstanding (DPO).
To calculate your CCC, use the following formula:
Cash Conversion Cycle = DIO + DSO – DPO
E-commerce businesses use CCC to measure how effectively they’re managing their working capital. A low, or even negative, number is ideal because it means your business is more liquid.
Cash Flow
Cash flow is the amount of money that moves in and out of a business over a given period of time. Any cash you receive is referred to as inflows, while cash you spend is called outflows. Positive cash flow means you have more money coming into your business than going out.
To determine your cash flow, subtract your operating expenses from the money you make on sales.
Cash Flow = Sales – Operating Expenses
Contribution Margin
Contribution margin tells you how much money the sale of a given product generates, after subtracting all the variable costs associated with that product’s production. These can include things like marketing costs, shipping, raw materials, wages, and utilities.
To calculate contribution margin, use the following formula:
Contribution Margin = Unit Revenue – Unit Variable Costs
Contribution margin is a way of measuring the success or profitability of each product in your catalog. It tells you which products are your money makers, and which might be costing you more than they’re worth. A negative contribution margin means you’re losing money on every sale.
Cost of Goods Sold
Cost of goods sold (COGS) are all the direct costs associated with producing the products a business sells, including raw materials, transportation, and labor. It tells you how much money your business spends on acquiring all of the products in its catalog.
COGS = Starting Inventory + Purchased Inventory – Ending Inventory
For a business to remain profitable, it needs to keep its COGS lower than its revenue. A business can reduce its COGS in a number of different ways, like reducing supply costs, discontinuing unpopular products, or optimizing inventory management.
Credit Score
A business credit score is a measure of how likely a business is to pay borrowed funds back on time. It works a lot like a personal credit score. A business credit bureau builds a profile of your company’s financial history, and generates a score. Lenders, vendors, suppliers, and others use this information to determine how likely you are to pay back your debts on time.
Business credit scores are calculated using a number of different formulas and factors, and they’re typically on a scale of 0 to 100. They generally factor in your business’s payment history, number of employees, amount of debt relative to credit, the length of your credit history, and more.
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Current Assets
Current assets, also known as liquid assets, are all the resources a company could convert to cash within one year or one operating cycle. They include things like cash and cash equivalents, accounts receivable, inventory, marketable securities (stocks, bonds, mutual funds), and prepaid liabilities.
Your current assets measure your company’s short-term liquidity and ability to meet its financial obligations. They can also give you a good sense of the value of your business.
Customer Acquisition Cost
Customer acquisition cost (CAC) is the total amount of money it takes to persuade a potential customer to buy your product or service, including all of the associated sales and marketing costs, over a particular period of time.
To calculate your CAC, use the following formula:
CAC = (Marketing Expenses + Sales Expenses) / Number of New Customers Acquired
When customer acquisition costs are high, it can be useful to lean into other revenue-boosting tactics, such as increasing your average order value, improving customer retention, or lowering your COGS.
Customer Lifetime Value
Customer lifetime value (LTV) is a measure of the total revenue a customer contributes to a business over the duration of their relationship with the company, or the average amount they’re expected to spend over that same timeframe.
To calculate LTV, use the following formula:
LTV = Customer Value x Average Customer Lifespan
Average customer lifespan refers to the amount of time between a customer’s first and last purchase from your company.
Average customer lifetime value helps you understand who your customer base is, measure brand loyalty, and know where to target your marketing and retention efforts. It also helps you determine your business’s long term viability and product-market fit.
Debt-to-Equity Ratio
Debt-to-Equity Ratio, or D/E Ratio, is a straightforward measure of a company’s total debt relative to its shareholder equity. It tells you which you’re using more of in order to run your business and finance your assets.
To calculate D/E ratio, use the following formula:
D/E = Total Debt / Total Shareholder Equity
A low D/E ratio implies you’re not using a lot of debt to fund your business, while a high D/E tells potential lenders you’re already borrowing a lot.
Depreciation
In business finance, depreciation refers to an accounting method of spreading the cost of an asset out over its lifetime. It can help businesses estimate how long an asset will continue generating revenue. It is not related to the physical condition of the asset.
The most common method for calculating depreciation is the straight line method, which is calculated using the following formula:
Depreciation Value per Year = (Asset Cost – Salvage Value) / Useful Life
There are also several other methods for calculating depreciation, including the double-declining balance method, sum-of-the-years’ digits, and units of production.
EBITDA
EBITDA stands for “earnings before interest, taxes, depreciation, and amortization”. It helps measure a company’s core profitability, especially relative to competitors, and can be an important tool in gaining investor interest.
To calculate EBITDA, most companies use the following formula:
EBITDA = Net Income + Interest + Income Tax + Depreciation / Amortization
However, some companies calculate EBITDA differently, leaving out important expenses or using it to prevent a more flattering image of their performance. And because EBITDA leaves out capital expenditures all together, it’s not in-and-of-itself an accurate measure of a company’s financial success.
Economies of Scale
Economies of scale occur when a company increases its production to a degree that enables it to save costs. In other words, your costs per unit decrease as you produce more units of the same item, and your overall production becomes more efficient.
Economies of Scope
Economies of scope are factors that make it more cost effective to produce a greater variety of products or services. In other words, the more new products you add to your catalog, the more you save on production costs per item. This often happens when different SKUs use some of the same parts, are made using the same machinery, or use the same distribution channels.
Fixed Costs
A company’s fixed costs, also known as overhead, are expenses that aren’t impacted by how much it produces. They’re often costs that aren’t immediately related to production, like rent, salaries, utilities, and insurance. They might change according to other market factors, but they aren’t dependent on your production volumes.
Leveraged Buyout
A leveraged buyout (LBO) is when one company purchases another primarily using borrowed funds. The acquiring company usually invests around 10% to 30% of equity, while the remaining funds (leverage) — up to 90% — come from bonds and/or loans.
Sometimes considered a predatory business tactic, private equity firms may use LBOs to acquire companies without incurring much of the risk. The target company, meanwhile, doesn’t have much control over the deal, and may be at risk for bankruptcy or other harmful consequences.
Liabilities
In business financing, liabilities are any debts a business owes. In other words, any cash or other assets your business must eventually repay to another entity. These can include legal debts, loans, wages, and any other outstanding money owed.
Marginal Cost
Marginal cost refers to an increase or decrease in production costs when a business produces one more unit or serves one more customer. Also known as incremental cost, businesses often use it to determine how much to produce, and how to price their products.
To calculate marginal cost, use the following formula:
Marginal Cost = Change in Total Cost / Change in Quantity Produced
Marginal cost can also be used as a way to predict how a company’s profits might increase as it scales.
Market Liquidity
Market liquidity measures how quickly or easily large assets can be bought or sold, as well as the stability of pricing. A more liquid market is good for e-commerce because it promotes investor confidence. It’s generally considered less volatile and less prone to financial crisis.
High liquidity means both supply and demand are high, and it’s easy to find a buyer or a seller. Sellers don’t have to cut prices to make a sale, and buyers don’t need to pay unreasonably high prices.
Merchant Cash Advance
A merchant cash advance (MCA) is a lump sum cash advance that often comes with a flat fee also known as a factor rate. After deducting fees, funds are disbursed to a business daily or weekly. MCA providers take repayments via holdback percentage — a percentage deducted directly from your transactions and paid back directly to the lender.
Some e-commerce businesses use MCAs because they’re processed much quicker than traditional bank business loans — you can usually get funds within three days. However, depending on the type of MCA, they can be more expensive or come with restrictions on how the funds can be used.
Net Operating Income
Net Operating Income (NOI) is a company’s direct profit, after direct operating expenses, like administrative, marketing, and other industry-specific costs, are subtracted from income.
To calculate NOI, use the following formula:
NOI = Revenue – Direct Operating Expenses
Net operating income can help a company understand how effectively it’s managing operating costs, and how efficient it is at generating revenue.
Overhead Costs
Overhead costs are all of the expenses a business incurs, excluding direct production costs like materials and labor. They can include things like rent, utilities, insurance, and other general costs of operating a business.
Profit
Profit is the money generated by a business when its total revenue is higher than its total costs. Gross Profit describes total profit after subtracting the cost of goods sold. Net Profit refers to the amount you get after subtracting all of your expenses.
Profit Margin
Profit margin is a ratio for measuring the amount of profit a company makes. In other words, it’s the percentage of income that’s left over after your expenses are paid.
To calculate gross profit margin, use the following formula:
Gross Profit Margin = (Revenue – COGS / Revenue) X 100
To calculate net profit margin, incorporate all other operating expenses, like rent, utilities, marketing, payroll, taxes, etc.
Net Profit Margin = (Revenue – COGS – Expenses / Revenue) * 100
Increasing your profit margins is the heart and soul of operating a successful business. It’s usually done through a combination of increasing sales, reducing costs, and optimizing production.
Return On Investment
Return on investment, or ROI, is a basic measure of how profitable a given investment is for a business, relative to its cost. ROI is calculated as a ratio of net profit to total cost of said investment.
There are a number of formulas to calculate ROI, the most common of which are:
ROI = (Net Income / Cost of Investment) x 100
ROI = (Final Value of Investment – Initial Value of Investment / Cost of Investment) x 100%
The term ROI is also often used to talk about whether or not a particular initiative, such as a marketing campaign, is worthwhile.
Revenue
Revenue is the total amount of money a business generates through its normal business operations (i.e., sales of goods and/or services) over a given period of time, before business expenses are subtracted.
At the most basic level, revenue is calculated using the following formula:
Revenue = Price x Units Sold
In e-commerce, you can calculate gross revenue using the following formula:
Gross Revenue = (Price per Product or Service) x (Total Number of Products or Services Sold)
To get net revenue, subtract returns, discounts, and allowances from gross revenue:
Net revenue = (Gross Revenue) – (Returns + Discounts + Allowances)
Revenue-Based Financing
In revenue-based financing, a businesses repays its lenders by disbursing a certain percentage of its revenues until a predetermined amount has been paid. This amount is usually somewhere around three to five times the amount of the initial loan or investment.
Unlike debt financing options, repayments aren’t fixed, and they don’t have interest rates. Instead, they’re directly tied to the business’ performance. Unlike equity financing, in revenue-based financing, lenders don’t become shareholders of the business.
Valuation
Valuation is the process of determining the worth of a company, investment, or asset. Company valuation, also known as business valuation, is used to determine the fair worth of an e-commerce business. It usually includes an analysis of a company’s management, future earnings potential, capital structure, and the market value of its assets.
You might need to participate in a company valuation if you decide to sell all or part of your business, or merge with or acquire another company.
Working Capital
Working capital is the amount of cash a business has on hand for its day-to-day operations. It’s a strong measure of the liquidity and financial health of a company, as well as of its operational efficiency.
To calculate working capital, use the following formula:
Working Capital = Current Assets – Current Liabilities
Working capital can be used to invest in all aspects of a business, including inventory, advertising, R&D, and more.
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Understanding your finances can give you a clearer picture of what is and isn’t working for your business, so you can take the right action at the right time.
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