In the realm of business, understanding financial terminology is essential. It unlocks insights, reveals trends, and empowers decision-making

At the "I Hate Numbers" podcast, we're committed to demystifying the complex world of numbers. In this episode, we'll delve into the essential concepts of capital and operating expenses, shedding light on their significance for businesses across diverse sectors.

Explaining Capital Expenses

Capital expenses are the backbone of business investment, laying the foundation for future growth and prosperity. Whether you're an arts organization, restaurateur, manufacturer, or airline company, capital expenses encompass vital infrastructure and assets. Think lighting equipment for theatres, ovens for restaurants, machinery for manufacturers, and planes for airlines. These investments, also known as fixed assets or non-current assets , are pivotal for long-term success.

Understanding Operating ExpensesExplaining assets and liabilities

Operating expenses, on the other hand, fuel the day-to-day operations of a business. From electricity bills to maintenance costs, operating expenses ensure the smooth functioning of capital investments. Whether it's powering equipment in an arts organization, maintaining kitchen appliances in a restaurant, or servicing machinery in a manufacturing plant, operating expenses are indispensable. They're the lifeblood that sustains business operations, often referred to as overheads or running costs.

Differentiating Capital and Operating Expenses

While capital expenses pave the way for future growth, operating expenses directly impact profitability. The key distinction lies in their treatment within profit calculations. While capital expenses are excluded from profit calculations, operating expenses play a crucial role in determining net profit. Understanding this difference is paramount for effective financial management and strategic decision-making.

Exploring Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) represents expenses directly attributable to the production of goods or services. Whether it's actors' fees for performances, ingredient costs for restaurants, or raw materials for manufacturers, COGS encapsulates essential expenditures. This metric provides insights into the profitability of core business activities, serving as a cornerstone for financial analysis.

Importance of Profit Measurement

Profit serves as the ultimate gauge of business performance; consequently, it reflects the effectiveness of financial strategies and operational efficiency. Gross profit and operating profit are key metrics; therefore, they encapsulate revenue generation and expense management. Whether it's EBIT or PBIT, understanding these profit figures is essential for assessing business viability and sustainability.

Conclusion

Understanding financial terminology is not just a matter of semantics; it's a strategic imperative for businesses of all sizes. By deciphering concepts like capital and operating expenses, businesses can navigate the intricacies of financial management with confidence and clarity. Join us at the "I Hate Numbers" podcast as we continue to unravel the mysteries of finance and empower entrepreneurs worldwide.

Listen to the "I Hate Numbers" podcast for more insights into financial management and business success.

All professions, all industries, all sectors have their own particular language, their own particular jargon. Understanding what that language actually is, understanding the frameworks is a great way to build up awareness аnd access what's going on. And that's no different in the world that I inhabit, the world of numbers. In this week's I Hate Numbers Podcast,

I'm going to be answering six key questions. Those six key questions will give you a better insight into the world of numbers and understanding what's going on in your own business, whether that's an arts and social enterprise, whether that's a private business, a sole trader, a partnership, doesn't really matter.

Those terms are ones that are used throughout.

You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

What are those six questions? Well, what are capital expenses? What are operating expenses? What's the key difference between a capital and an operating expense? Why does it matter to your business? How do you actually calculate operating expenses? And lastly, what's the difference between cost of goods sold and operating expenses?

All is going to be revealed, folks. Let's crack on with the podcast. Let me firstly deal with capital expenses. Now, capital expenses are expenses, items, that are invested on and in your business. Typically, they are ones that provide some degree of infrastructure for your business, and are there to help you generate future benefits for your business.

What are some examples? Well, some examples would be if you're an arts organisation, then the lighting equipment, the sound equipment that you have, would be classified as a capital expense, a capital item. If you're a restauranteur, the ovens, the fridges, the microwaves, the tables and chairs that you have are also examples of capital expenses.

If you make things, you're a manufacturer, the machinery that you have, the workbenches, the delivery vans, and the computers are also examples of capital expenses. If you happen to be an airline company, then the planes, the hangars, the buildings, and the computers are also examples of capital expenses. Now, folks, in the world of finance, if one term exists, accountants will typically create another one.

If you hear the term fixed assets, if you hear the term non-current assets, if you hear the term CapEx, those are all essentially the same thing. Now, contrasting with capital expenses, we have what are called operating expenses, or what some people call revenue expenses. I'm going to use the term for now of operating expenses.

Now these are ones that you have for the day-to-day running of your business, and typically they're connected to and associated with the capital items that we listed earlier. If you imagine that lighting equipment, if you imagine the sound equipment, then to operate them, you need electricity to power them.

And electricity will be an example of an operating expense. So that arts organisation, the electricity, the maintenance, the repairs, the replacement of the bulbs in there, people to operate the equipment, will be all examples of operating expenses, brackets, revenue. If you're a restaurateur, the electricity to power the ovens, the front-of-house staff, the repairs, the advertising, the people who work in the kitchens, all examples of operating expenses.

Let's think manufacturer. Now, you've got the machine, machines break down, they need servicing, the repairs, the maintenance. That would all be examples of operating expenses. The fuel that goes in the vans, the insurance, the van tax, the delivery driver's wages are all examples of operating expenses. Can you see a pattern emerging here, folks?

For the airline company, typically it's the ground crew, the pilots, the stewards, the baggage handlers' wages, the plane maintenance, the advertising. Those are some examples. The list is endless. Now, as we had for capital expenses, we had alternative terms. If you hear terms like overheads, running cost, OPEX, fear not.

These are just operating expenses under a different name, a different guise. That's two of the questions answered. What's question number three? Well, question number three is: What's the key differences between the two? Well, the key difference between the two, a capital expense item in itself is not used to calculate what most organisations are there to do

i.e. generate profit. Profit does not take into account the money that you've expensed and incurred on capital items. Instead, operating expenses are used in the calculation of the profits that you generate. Now, what I want to do, I want to talk about cost of goods sold. We're going to come back to profit measurement in but a few moments.

Now cost of goods sold, also called cost of sales, are expenses that are easily traceable and linked to the products or services that you sell. So in our arts organisation, the cost of the actors who are performing, the cost of any venues that you hire, will be example of cost of goods sold. Notice there's no physical good that's sold, it's a service that's provided, but the term still applies.

For the restaurateur, the food ingredients, the wages of the chef, the wines and spirits that you buy in to sell on, all examples of cost of goods sold. For a manufacturer, the raw materials that ends up in the product, the salaries paid to the production staff, the electricity that powers the machines that make the product, are also examples of cost of goods sold.

And for the airline, the fuel for the aircraft, the pilots' and the cabin crew's wages, and the food that's served on the airplane, is also an example of cost of goods sold. In some other circles, by the way, cost of goods sold can also be called a direct cost, and as a working title, that's perfectly acceptable.

Now profit, I flagged up earlier on. One key measure of financial performance is profit, and profit is a noble objective. Whether you're an arts and social enterprise, a charity, a private business, profit is effectively recouping the costs that you've expensed, giving you something that goes back into reserves and helps you build up sustainability and viability.

Profit is a vital number, is used to build sustainability, monitor and manage, and measure your performance. The two profit numbers that we typically come across are gross profit and operating profit. Gross profit, or gross margin if you prefer, is your business turnover i.e. what you're selling, minus the cost of goods sold that we mentioned earlier.

Operating profit is the gross profit subtracting all your operating expenses. Now we talked about alternative terms above and operating profit is no exception. It's also known as EBIT, which stands for earnings before interest and tax, and earnings, by the way, is the international word for profits. There is a UK equivalent.

It's called PBIT, P B I T, and that stands for profit before interest and tax. And lastly, a bit of an old-fashioned one, perhaps in some circles, but I still like that, it's one called net profit. All those profit figures by the way folks are disclosed in what's called your profit and loss statement. Capital expenses are not included as we mentioned earlier when profit is calculated.

Now, a profit & loss statement is also known as a P& L. Also referred to as an income and expenditure statement or sometimes refer to as a statement of profit or loss. Capital expenses are shown separately within your organisation's balance sheet and a balance sheet is merely a list of the items of value and the items that represent debt to your organisation and it's a statement of financial strength.

There are also different tax treatments for those two items but that's a topic for another podcast. Now, folks, I hope you found that insightful. I hope you found that useful. If you'd like to learn more, then check out the resources. There's a link. We have access to lots of resources here, which goes into these topics.

And we also have a waiting list that we're building up for an opportunity here for people to join and learn more and if you'd like to do so then have a look at the link and we can share that information with you. Until next time folks, happy phraseology. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.