Karen Berman

Amortization is the same basic idea as depreciation, but it applies to intangible assets.

Operating profit is gross profit minus operating expenses, which include depreciation and amortization. In other words, it shows the profit made from running the business.

EBITDA (pronounced EE-bid-dah), or earnings before interest, taxes, depreciation, and amortization. Some people feel EBITDA is a better measure of a company’s operating efficiency, because it ignores noncash charges such as depreciation altogether.

Aside from monkeying with the books, there are only three possible fixes for low profitability. One, the company can increase profitable sales. This solution almost always requires a good deal of time. You have to find new markets or new prospects, work through the sales cycle, and so on. Two, it can figure out how to lower production costs and run more efficiently—that is, reduce COGS. This, too, takes time: you need to study the production process, find the inefficiencies, and implement changes. Three, it can cut operating expenses, which almost always means reducing the headcount.

Contribution margin indicates how much profit you are earning on the goods or services you sell, without accounting for your company’s fixed costs. To calculate it, just subtract variable costs from sales.

When you increase the bad-debt reserve on the balance sheet, you have to record an expense against profit on the income statement.

The rule allows (and in some cases requires) certain classes of assets to be listed at their current market value. To qualify for this kind of treatment, assets must meet two criteria. One, their value must be able to be determined without an appraisal. Two, they must be held by the company as short-term investments.

In fact, companies with particularly low debt-to-equity ratios may be targets for a leveraged buyout, in which management or other investors use debt to buy up the stock

The lease payments count as an expense on the income statement, but there is no asset and no debt related to that asset on a company’s books. Some companies that are already overleveraged are willing to pay a premium to lease equipment just to keep these two ratios in the area that bankers and investors like to see.

The Big Five are:

• Revenue growth from one year to the next

• Earnings per share (EPS)

• Earnings before interest, taxes, depreciation, and amortization (EBITDA)

• Free cash flow (FCF)

• Return on total capital (ROTC) or return on equity (ROE). ROE is the right metric for financial businesses such as banks and insurance companies.