Profit is profit… what is there to discuss? Maybe alot. It often pays to ask, “What do you mean by that?”
During business literacy trainings we use Income/Outcome® business simulations to familiarize employees with fundamental concepts in finance, like:
- What is profit?
- What is a fixed cost?
- What is depreciation?
You might look at the above list and think “profit is profit- what is there to discuss?!” But we caution trainees that finance terminology can differ from one organization to the next – and for good reason: One company (or division) might use a term one way while another company (or division within the same company) might use the same term in a different way.
Crucial questions
So we try to make a habit — and enourage others to make a habit — of asking a very basic finance question, namely: “What do you mean by that?”
I’ll give you an example showing how important this question is:
Today, someone brought up Return on Sales or the Profitability Ratio. This is how, at Income/Outcome, we define Return on Sales:
Return on Sales = Net Income/Sales
Investopedia has an extensive finance glossary, and their definition of ROS is somewhat different:
Return on Sales = (Net Income – Interest – Tax)/Sales
And, to further complicate things, this ROS definition is similar to our definition of Operating Margin, which is:
Operating Margin = Operating Income/Sales
So their Return on Sales is our Operating Margin. And what does Investopedia call our Return on Sales? They call it Profit Margin!
Ask “What do you mean by that?“
We always tell people to ask about finance terms like Profit Margin. Any word that has ambiguous meaning is a what-do-you-mean-by-that term; the phrase reminds us that a term can have several meanings for different people.
Recognizing differences
I’ve thrown various words and formulae at you in this article, and I know it’s difficult to keep track. That’s the point! Often we have the same terminology and concepts, but we use them and define them differently.
My view is that people can use the same word or phrase, and define it differently, without being ‘wrong’ – there are plenty of conflicting definitions that are in common use in the world of business. That is why it’s important to have a solid understanding of the underlying concepts, so as to be confident in seeking clarification of individual words and phrases in a particular situation.
And it always pays to ask, “What do you mean by that?”
Your turn
Have you run into this issue of two people meaning different things when they use a term? How do you figure out that it is happening? How do you resolve it?