Here are twenty terms and ten key distinctions that investors often confuse.

Fixed costs vs. variable costs

Fixed costs do not change with production or sales volume.

Variable costs fluctuate with production or sales volume.

Example: The rent a pizza restaurant pays is a fixed cost. This will not change no matter how many pies the pizzeria sells.

The materials that a pizza shop uses to make pizzas are variable costs. These costs rise as the shop sells more pizza because it will need more dough, sauce, and cheese.

EBITDA vs. net income

EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization.

Net income is the total profit after all expenses, including interest, taxes, depreciation, and amortization.

The cable industry pioneer John Malone developed the metric in the 1970s to sell investors on his company’s true profitability, which he believed was not accomplished by GAAP figures such as net income.

Charlie Munger, Warren Buffett’s famed business partner, called EBITDA "bulls**t earnings" because it did not always accurately reflect a company’s earnings. For instance, because EBITDA does not consider all business activities, it might overstate cash flow. 

Revenue vs. profit

Revenue is the total income generated from sales or services before deducting expenses.

Profit is the net income after deducting all expenses.

Both revenue and profit are found on the income statement.

CapEx vs. OpEx

Capital expenditures (CapEx) are the funds a company uses to acquire, upgrade, and maintain physical assets such as buildings, factories, and equipment.

Operating expenditures(OpEx) are the day-to-day business expenses, such as salaries, rent, and utilities. 

When our pizza shop owner expands their restaurant to put in new ovens, that’s an example of CapEx. Operating expenses are when the owner pays the electric bill or buys more cheese and sauce.

Accrual accounting vs. cash accounting

Accrual accounting anticipates financial events and transactions, while cash accounting records them as they occur (e.g. when the cash actually leaves the customer and is received by the business).

Accrual accounting follows the matching principle, ensuring that revenue and related expenses are recorded in the same accounting period to represent a business’s profitability accurately.

Cash accounting does not follow the matching principle, meaning that revenue and expenses might not be matched to the period in which they were incurred or earned.

The income statement and balance sheet use accrual accounting, while the cash flow statement uses cash accounting.

Market cap vs. enterprise value

The market cap is the total value of a company’s outstanding shares.

Enterprise value is the total value of a company, including debt and excluding cash.

Assets vs. liabilities

Assets are any item of property owned by the company that has value.

These include tangible assets(things that can be touched) such as real estate, factories, and equipment. They also include intangible assets (things that can't be touched), such as goodwill from past acquisitions, copyrights, and patents.

Liabilities are a company's financial obligations owed to others. These could include interest and payments on debt, worker pension programs, and taxes.

Both assets and liabilities are found on companies' balance sheets.

Gross margin vs. net margin

Gross margin is the gross profit divided by revenue. Gross profit is revenue minus the cost of goods sold (COGS).

Gross margin is a profitability metric that indicates the percentage of revenue after subtracting the COGS.

Net margin is net income divided by revenue. It is the percentage of net income relative to total revenue.

Return on investment (ROI) vs. return on equity (ROE)

Return on investment (ROI) measures profitability relative to total investment.

Return on equity (ROE) measures profitability relative to shareholder equity.

Shareholder equity is found on the balance sheet and is the equivalent of a person’s net worth on paper. It is the dollar amount that would be returned to shareholders if all of the company’s assets were liquidated and its debts settled. 

Financial leverage vs. operating leverage

Financial leverage is the use of debt in a company’s capital structure to amplify net income.

Operating leverage is the use of fixed instead of variable costs to amplify net income as revenue increases.

Key Takeaway

Understanding the distinctions between these key financial terms is crucial for investors looking to make informed decisions.

Each pair of concepts sheds light on different aspects of a business’s operations, profitability, and financial health, offering valuable insights into its performance and strategies. By mastering these distinctions, investors can better evaluate companies, assess risks, and identify opportunities that align with their goals.

Ultimately, financial literacy empowers smarter, more strategic investing.