A lot of business vocabulary sounds like it belongs to accountants and bankers, and so owners tend to leave it to them. That's a costly habit, because these words are the instruments for seeing what is happening inside a business. Each one is a particular way of looking at the same reality, the money coming in and going out, and each one shows you something the others hide. An owner who knows only "sales" and "the bank balance" is looking at the business through two small windows.
So this page follows the order the money actually moves, because the terms build on each other: first how a business earns, then where its money sits, then how cash moves, then borrowing, planning, customers and a few things specific to Sri Lanka. Each entry says what the term means, how it connects to its neighbours, and why it matters. Where it helps, there's a worked example, mostly using the same small retailer, so the numbers connect too.
The retailer, for reference: in a typical month it sells LKR 2,000,000 of goods that cost it LKR 1,200,000, and it spends LKR 650,000 on everything else.
One way to hold all of this together before the details: picture water moving through a house. Revenue is the water coming in at the tap. Costs are the water running out through the drains. Profit is whether, over a month, more came in than went out. Cash is how much is in the tank right now. And working capital is the water sitting in the pipes: already paid for, and not yet back in the tank. Most of the terms below are names for one of those things, measured at a particular point. Keep the picture in mind and the vocabulary has somewhere to attach.
Part 1. How a business earns
Revenue
Revenue is the value of what the business sold in a period, before any costs come off. You'll also hear it called sales, or, especially in Sri Lanka, turnover. The retailer's monthly revenue is LKR 2,000,000.
Revenue is counted when the sale is made, whether or not the customer has paid yet. That single convention is the root of the difference between profit and cash, which runs through this whole page.
If you're VAT-registered, revenue is the figure before VAT. The VAT you collect belongs to the Inland Revenue Department (see VAT, below).
Cost of goods sold
Cost of goods sold, often shortened to COGS, is the direct cost of the things you sold: the goods you bought to resell, the raw materials, the packaging, and sometimes the labour that goes straight into making each item. The retailer's cost of goods sold is LKR 1,200,000.
The word that matters is "sold." If you buy LKR 1.5 million of stock in a month but only sell LKR 1.2 million worth (at cost), your cost of goods sold is LKR 1.2 million. The other LKR 300,000 is still sitting on the shelf as inventory.
Gross profit
Gross profit is revenue minus cost of goods sold.
LKR 2,000,000 − LKR 1,200,000 = LKR 800,000
It tells you how much each rupee of sales leaves behind to pay for everything else. It says nothing yet about whether the business as a whole is profitable.
Gross margin
Gross margin is gross profit as a share of revenue.
LKR 800,000 ÷ LKR 2,000,000 = 40%
So for every LKR 100 the retailer sells, LKR 40 is left after paying for the goods. Gross margin is the number to watch for pricing, supplier costs and discounts, because those three move it directly.
The formula people search for most is just this: gross profit margin = (revenue − cost of goods sold) ÷ revenue × 100.
Markup
Markup measures the same profit as gross margin, but compares it to the cost instead of the price.
An item that costs LKR 1,000 and sells for LKR 1,500 has a markup of 50% (500 ÷ 1,000) and a margin of 33.3% (500 ÷ 1,500).
Margin and markup describe the same sale from two directions, and confusing them is one of the most common ways to underprice. If you want a 40% margin and add 40% to the cost, you get a 28.6% margin. To hit a target margin, divide the cost by one minus the margin: LKR 1,000 ÷ 0.60 = LKR 1,666.67. (More in our guide to pricing and margins.)
Fixed costs and variable costs
A variable cost rises and falls with how much you sell: goods, materials, packaging, delivery per order, sales commission.
A fixed cost stays roughly the same whatever you sell, at least over a few months: rent, salaries, insurance, software.
Between them sit semi-variable costs, like electricity in a factory, which has a fixed base and a part that rises with production, and step costs, which are fixed until you cross a threshold and then jump, like hiring another person once the team can't handle the volume.
Knowing which is which matters, because when sales fall, variable costs fall with them and fixed costs don't.
Overheads
Overheads are the costs of running the business that don't belong to any single sale: rent, salaries of people who aren't making the product, utilities, marketing, accounting, insurance. Most overheads are fixed costs. The retailer's overheads are LKR 650,000 a month.
"Expenses" is the broader everyday word for any cost the business pays. In accounts, expenses usually means overheads plus other costs like interest, as distinct from cost of goods sold.
Contribution margin
Contribution margin is what each sale contributes towards covering fixed costs, after its own variable costs. It's price minus variable costs per unit, or, as a percentage, (revenue − variable costs) ÷ revenue.
For a simple retailer, whose only variable cost is the goods, contribution margin and gross margin are the same: 40%. For a business with other variable costs, delivery per order or commission per sale, contribution margin is lower than gross margin, and it is the more honest number for decisions about pricing and volume.
Break-even point
The break-even point is the level of sales at which the business covers all its costs and makes neither a profit nor a loss.
Break-even sales = fixed costs ÷ contribution margin
LKR 650,000 ÷ 0.40 = LKR 1,625,000 a month
Below that, every month loses money. Above it, every extra LKR 100 of sales adds LKR 40 of profit. It's the single most useful number for asking "what happens if sales drop?" or "can we afford this new hire?" A new LKR 80,000-a-month salary raises the break-even point by LKR 200,000 of sales (80,000 ÷ 0.40).
Operating profit
Operating profit is gross profit minus overheads: what the business earns from its normal operations, before interest on loans and before tax.
LKR 800,000 − LKR 650,000 = LKR 150,000
You'll sometimes see EBIT (earnings before interest and tax), which means roughly the same thing, and EBITDA, which also adds back depreciation and amortisation. EBITDA is popular in valuations because it strips out the effects of how a business is financed and how it accounts for its equipment, which makes businesses easier to compare. It's also easy to misuse, because a business with expensive machines that wear out still has to replace them.
Net profit
Net profit is what's left after every cost: cost of goods sold, overheads, interest and tax. It's the last line of the profit and loss statement.
If the retailer has no loans and we look at it before tax, net profit equals operating profit: LKR 150,000 a month.
Net margin
Net margin is net profit as a share of revenue.
LKR 150,000 ÷ LKR 2,000,000 = 7.5%
Gross margin tells you whether each sale is worth making. Net margin tells you whether the whole business is worth running. A business can have a healthy gross margin and a thin net margin, which points at overheads, or at not enough volume to carry them.
Profit
So "profit" on its own is ambiguous. There are at least three of them, gross, operating and net, and each answers a different question. When someone says a business is "profitable," it's worth asking which profit they mean.
What all three have in common is that they are measured on the accrual basis: sales counted when made, costs counted when incurred. None of them is cash.
Part 2. Where the money sits
Assets, liabilities and equity
An asset is something the business owns that has value: cash, money customers owe it, stock, equipment, vehicles, property.
A liability is something the business owes: money owed to suppliers, loans, tax due, salaries due.
Equity is what's left for the owners: assets minus liabilities. It's the part of the business that belongs to you after every debt is paid.
These three are tied together by one equation, which is the whole logic of the balance sheet: assets = liabilities + equity. Everything the business owns was paid for either by someone it owes, or by its owners.
Balance sheet
The balance sheet is a snapshot of assets, liabilities and equity at one moment in time, usually the last day of a month or year.
It's the statement owners tend to look at least, and it explains a lot of cash problems, because receivables, inventory and payables all live here, and changes in them are where cash goes when profit doesn't show up in the bank.
Profit and loss statement
The profit and loss statement, also called the P&L or income statement, shows revenue, costs and profit over a period: a month, a quarter, a year. Where the balance sheet is a photograph, the P&L is a film of what happened between two photographs.
Cash flow statement
The cash flow statement shows how the cash balance changed over a period, and why. It's the bridge between profit and cash, and it's split into three parts:
Cash from operating activities: cash generated by the normal running of the business. It starts from profit and adjusts for things like changes in receivables, inventory and payables.
Cash from investing activities: cash spent on, or received from, long-term assets: buying equipment, selling a vehicle.
Cash from financing activities: cash from or to lenders and owners: taking a loan, repaying it, the owner putting money in or taking it out.
Add the three together and you get the change in the bank balance. When people search "cash in cash flow statement," this is the structure they're looking for.
Receivables
Receivables, also called debtors or accounts receivable, is the money customers owe you for sales you've already made. It's an asset, and it's a sale that has counted towards profit but hasn't yet become cash.
A useful measure is debtor days: how long customers take to pay, on average. Receivables ÷ annual sales × 365. If the retailer is owed LKR 4 million and sells LKR 24 million a year, debtor days are about 61.
Payables
Payables, also called creditors or accounts payable, is the money you owe suppliers for things you've already received. It's a liability, and it's the mirror image of receivables: your suppliers are, in effect, lending you their money until you pay.
Creditor days measures how long you take to pay: payables ÷ annual purchases × 365.
Inventory
Inventory, or stock, is goods you've bought or made but not yet sold. It's an asset, and it's cash in another form: money that has left the bank and is sitting on a shelf waiting to come back. Stock days measures how long it sits: inventory ÷ annual cost of goods sold × 365.
Working capital
Working capital is the money tied up in running the business day to day. There are two definitions, and both are useful.
The accounting definition is current assets minus current liabilities: everything the business owns that will turn into cash within a year (cash, receivables, inventory) minus everything it owes within a year (payables, short-term loans, tax due). It measures whether the business can meet its near-term obligations.
The operating definition, the one most useful to an owner, is receivables plus inventory minus payables. It measures how much of your own money the operation swallows to keep going.
For a distributor selling LKR 3 million a month at a 25% gross margin, with 60 days of receivables, 45 days of stock and 30 days of payables, operating working capital is about LKR 7.1 million. That's money the business needs permanently, just to run, and it grows whenever sales grow.
Cash conversion cycle
The cash conversion cycle is how long a rupee spends inside the business, from the moment you pay a supplier to the moment a customer pays you.
Cash conversion cycle = stock days + debtor days − creditor days
45 + 60 − 30 = 75 days
The longer the cycle, the more working capital the business needs. Shortening it, by collecting faster, holding less stock or paying suppliers on longer terms, releases cash without earning a rupee more profit.
Current ratio
The current ratio is current assets divided by current liabilities. If a business has LKR 9 million of current assets and LKR 6 million of current liabilities, the ratio is 1.5: it has LKR 1.50 of short-term resources for every LKR 1 it owes in the short term. Banks look at it as a quick check on liquidity, which means the ability to pay bills as they fall due.
Depreciation
Depreciation spreads the cost of a long-life asset over the years it's used, instead of counting it all as a cost in the month you bought it.
A delivery van that costs LKR 6,000,000 and is expected to last five years might be depreciated at LKR 1,200,000 a year, or LKR 100,000 a month. That LKR 100,000 is a cost on the P&L every month, even though no cash leaves the business that month. The cash left all at once, on the day the van was bought.
That's why depreciation is one of the places where profit and cash diverge in the other direction: a business can show a lower profit than the cash it generates, because depreciation is a cost without a payment.
Capex and opex
Capex, capital expenditure, is spending on assets that last longer than a year: machines, vehicles, computers, renovations. It goes onto the balance sheet as an asset and reaches the P&L slowly, through depreciation.
Opex, operating expenditure, is spending that's used up within the period: rent, salaries, electricity, subscriptions. It hits the P&L immediately.
The same need can often be met either way. You can buy a van (capex) or lease one (opex). You can buy servers (capex) or pay for cloud software monthly (opex). The choice changes your cash flow, your profit, your balance sheet and what a bank sees, which is why it's worth deciding on purpose. (See our guide to buying or leasing.)
Part 3. How cash moves
Cash flow
Cash flow is the movement of money into and out of the bank over a period. Positive cash flow means more came in than went out.
Cash flow and profit measure different things. Profit counts a sale when it's made; cash flow counts it when the money arrives. Profit spreads the cost of a van over five years; cash flow counts the whole price on the day you pay. Over the very long run, the two converge. Over any month or quarter, they can be far apart, and most cash crises live in that gap. (See our guide to cash flow.)
Operating cash flow
Operating cash flow is the cash the normal running of the business generates in a period: cash from customers minus cash paid to suppliers, staff and for overheads. It's the first section of the cash flow statement, and for most small businesses it's the number that shows whether the business funds itself.
Free cash flow
Free cash flow is operating cash flow minus capital expenditure: the cash left after the business has paid for running itself and for the equipment it needs to keep running.
If a business generates LKR 1,800,000 of operating cash flow in a year and spends LKR 1,000,000 replacing equipment, its free cash flow is LKR 800,000.
Free cash flow is "free" in the sense that the owner can choose what to do with it: repay debt, pay themselves, build a reserve, invest in growth. It's one of the most important numbers in valuing a business, because what a buyer is really buying is the future free cash flow.
Cash flow forecast
A cash flow forecast predicts the bank balance into the future, week by week or month by month, by listing expected receipts and payments. Its job is to show tight periods before they arrive. For small businesses, a 13-week forecast in weekly columns is the most practical version, because it's long enough to catch every monthly cycle and short enough to be accurate.
Part 4. Borrowing
Collateral
Collateral, or security, is an asset a borrower pledges to a lender, which the lender can take if the loan isn't repaid: land or a building, a vehicle, equipment, a fixed deposit. A personal guarantee is a related idea: the owner promises to repay personally if the business can't.
Collateral answers the bank's second question, "what if this goes wrong?" Cash flow answers the first, "will this be repaid?"
Credit guarantee
A credit guarantee is a promise by a third party to cover part of a lender's loss if a loan goes bad. It reduces the lender's risk, which lets it lend with less collateral. In Sri Lanka, the National Credit Guarantee Institution has offered guarantees through participating banks and finance companies since January 2025.
Term loan and overdraft
A term loan is a fixed amount, borrowed once and repaid in instalments over a set period, usually years. It suits long-life assets: a machine, a vehicle, a building.
An overdraft or working capital facility is a credit limit you can draw on and repay as needed. It suits short-term gaps that close on their own: a seasonal stock build-up, a large order that pays in 90 days.
The principle is to match the shape of the loan to the life of the thing it pays for.
Debt service cover
Debt service cover compares the cash a business has available to the repayments it must make. If a business generates LKR 210,000 a month after all costs and its loan repayment is LKR 75,000, it covers the repayment 2.8 times. Banks look at this, in one form or another, to judge whether a loan is affordable. The higher the cover, the more room there is for a bad month.
Enterprise value and valuation
Valuation is working out what a business is worth. Owners usually come to it when selling, bringing in a partner or raising investment.
Enterprise value is the value of the whole business, regardless of how it's financed. One way to see it: the value of the owners' equity, plus the business's debt, minus its cash. If the equity is worth LKR 50 million, the business owes LKR 10 million and holds LKR 5 million in cash, the enterprise value is LKR 55 million. A buyer taking over the whole business inherits the debt and gets the cash, which is why both appear.
Small businesses are commonly valued as a multiple of profit or of free cash flow, or by estimating future free cash flow and working out what it's worth today (a discounted cash flow, or DCF). The multiple depends heavily on how predictable and how dependent on the owner the business is.
Part 5. Planning
Budget, forecast and actuals
A budget is a plan: what you decided the business should earn and spend, fixed at the start of a period.
A forecast is your current best estimate of what will actually happen, updated as you learn.
Actuals are what did happen, from the books and the bank.
They're three different things, and the useful information is in the gaps between them.
Variance
A variance is the difference between budget and actual for a line. Sales of LKR 1,850,000 against a budget of LKR 2,000,000 is an unfavourable variance of LKR 150,000, or 7.5%. One variance is information. The same variance three months in a row is a trend.
Sales driver
A driver is something that causes sales, and a forecast built from drivers multiplies them: customers × purchases per customer × average order value, or footfall × the share who buy × average spend. A forecast built from drivers can be checked against reality one piece at a time, which a simple growth percentage can't.
KPI
A KPI, key performance indicator, is a number you've chosen to track because it tells you whether the business is heading where you want it to. Good KPIs sit close to the outcomes you care about and are hard to improve without improving the business. A KPI that can be raised without the business getting better will usually end up being raised that way.
Part 6. Customers and sales
Average order value
Average order value is revenue divided by the number of orders. It's one of the three parts of sales, alongside the number of customers and how often they buy. Of the three, the number of customers is the one that moves most when a business grows.
Conversion rate
A conversion rate is the share of people who move from one step to the next: viewers who send an enquiry, enquiries that get a quote, quotes that become sales. If 40 of 1,000 viewers enquire, the conversion rate is 4%. Measuring each step shows you where people drop away.
Customer acquisition cost
Customer acquisition cost, CAC, is what it costs to win one new customer: marketing and sales spending in a period divided by new customers won. LKR 60,000 of marketing in a month that brings 12 new customers is a CAC of LKR 5,000.
Customer lifetime value
Customer lifetime value is the gross profit a customer brings over the whole time they buy from you. A customer who buys four times a year at LKR 25,000, at a 40% gross margin, brings LKR 40,000 of gross profit a year. If they stay three years, their lifetime value is about LKR 120,000.
Set it next to customer acquisition cost and you can see how much you can afford to spend winning a customer. Research on buying behaviour (the Ehrenberg-Bass Institute's work is the best known) finds that how often customers buy rises mainly with the size of the customer base, so lifetime value is mostly a result of growth rather than a lever you can pull directly.
Part 7. Sri Lanka specifics
VAT
Value Added Tax is charged on sales by VAT-registered businesses, at a standard rate of 18%. Registration becomes compulsory above a turnover threshold set by law; check the current threshold with the Inland Revenue Department. The VAT you charge customers isn't your revenue: you collect it on the IRD's behalf and pay it over, after deducting the VAT you paid on eligible purchases. Calculate margins on prices before VAT.
EPF and ETF
The Employees' Provident Fund and the Employees' Trust Fund are the two compulsory retirement-related contributions for private-sector employees. On gross earnings, the employer contributes 12% to the EPF and 3% to the ETF; the employee contributes 8% to the EPF, deducted from their pay. So a salary of LKR 100,000 costs the employer LKR 115,000.
CRIB report
A CRIB report is a record of your borrowing and repayment history held by the Credit Information Bureau of Sri Lanka. Lenders check it before they lend. You can request your own report, for yourself or your business, through CRIB's self-inquiry service at crib.lk, and it's worth doing before any loan application.
Post-dated cheque
A post-dated cheque is a cheque dated in the future, which can't be paid in until that date. In many Sri Lankan trades it's a common way of giving and taking credit. For cash flow purposes, a post-dated cheque is a receivable until its date, however certain it feels.
How the terms fit together
One event, several descriptions
These terms are distinct, and they aren't separable. Follow a single credit sale through them. The day you make it, it's revenue on the profit and loss statement and a receivable on the balance sheet. It adds to working capital, because the money is now sitting with your customer. Weeks later, when the customer pays, it becomes cash, and the receivable disappears. One event, described three or four ways depending on where you look and when.
Does that make sense? If it does, you've understood the most important idea on this page: the vocabulary exists so you can follow one thing through all the places it shows up, which is how you start to see the business as a whole, instead of as a pile of unconnected numbers.
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