About this episode

Every profession, industry and sector has its own language. The world of business finance is no different. When we understand the language of numbers, we can read our reports more confidently, ask better questions and make stronger decisions.

In this episode, we explain key financial terminology used across private businesses, arts organisations, social enterprises, charities, sole traders and partnerships. We focus on capital expenses, operating expenses, cost of goods sold, gross profit, operating profit, EBIT, PBIT, profit and loss statements, and balance sheets.

What you’ll learn in this episode

• What capital expenses mean in business finance.
• Why accountants may call capital expenses fixed assets, non-current assets or CapEx.
• What operating expenses mean and why they matter.
• The difference between capital expenses and operating expenses.
• How cost of goods sold differs from operating expenses.
• How we calculate gross profit and operating profit.
• Where these figures appear in financial statements.

Why financial terminology matters

Understanding financial terminology is not about using fancy words. Instead, it helps us understand what the words mean so we can see what is happening in the business.

Terms such as capital expenses, operating expenses, cost of goods sold, gross profit and operating profit often appear in conversations with accountants, advisers, funders and business owners. If we do not understand them, our financial reports can feel confusing.

However, when we understand the language, the numbers become more useful. They show how the business performs, where money goes, what assets the business owns, and how profit is measured.

What are capital expenses?

Capital expenses are items we invest in for the future benefit of the business. They usually provide infrastructure, capacity or long-term support for business activity.

For example, an arts organisation may buy lighting equipment or sound equipment. A restaurant may buy ovens, fridges, microwaves, tables and chairs. A manufacturer may buy machinery, workbenches, delivery vans or computers. An airline may buy planes, hangars, buildings and computer systems.

Accountants may also call capital expenses fixed assets, non-current assets or CapEx. These terms can sound different, but they broadly point to the same idea: assets that support the business beyond one short period.

If you want to understand the wider balance sheet language behind these items, our episode on Explaining assets and liabilities is a useful next step.

What are operating expenses?

Operating expenses keep the business running day to day. Accountants may also call them revenue expenses, overheads, running costs or OPEX.

These costs often support the capital items we have already bought. For example, lighting equipment needs electricity, maintenance and people to operate it. A restaurant oven needs electricity, repairs and staff to use it. A delivery van needs fuel, insurance, road tax, maintenance and a driver.

In simple terms, capital expenses help create capacity. Operating expenses help keep that capacity working.

Capital expenses versus operating expenses

The key difference is how we treat these expenses when we calculate profit.

We do not normally treat capital expenses as day-to-day running costs in the profit calculation. Instead, we show them separately as assets on the balance sheet because they provide future benefit to the business.

We include operating expenses when we calculate profit. These costs support the day-to-day running of the business and help us understand what remains after the business pays the costs needed to operate.

Therefore, this distinction matters because it affects how we read profit, performance, assets and financial strength.

What is cost of goods sold?

Cost of goods sold, often called cost of sales or direct costs, covers expenses that link directly to the goods or services the business sells.

For an arts organisation, that might include performers’ fees or venue hire for a specific production. For a restaurant, it could include ingredients, wine, spirits and kitchen wages linked to food production. For a manufacturer, it may include raw materials, production staff and electricity used to make the product.

Even when no physical product changes hands, the term can still apply. A service business also has direct costs connected to delivering its services.

Cost of goods sold versus operating expenses

Cost of goods sold links directly to what we sell. Operating expenses cover the wider costs of running the business.

For example, ingredients used in meals sold by a restaurant count as cost of goods sold. Advertising, front-of-house wages and general repairs may count as operating expenses.

This distinction helps us understand profit more clearly. Cost of goods sold helps us calculate gross profit. Operating expenses then help us calculate operating profit or net profit.

Gross profit explained

We calculate gross profit by taking turnover and subtracting cost of goods sold.

Turnover shows the value of sales. Cost of goods sold shows the direct cost of producing or delivering what we sold. Gross profit then shows how much remains after those direct costs come out.

Gross profit is useful because it tells us whether the core activity of the business is financially sound. If gross profit looks weak, we may need to review pricing, direct costs, delivery methods, product mix or margins.

For a focused explanation, listen to What Is Profit? Gross Profit and Net Profit Explained.

Operating profit explained

We calculate operating profit by taking gross profit and subtracting operating expenses.

Operating expenses may include administration, advertising, repairs, maintenance, rent, support staff, delivery costs, software, professional fees and other overheads.

Accountants also use other names for operating profit. The transcript refers to EBIT, which means earnings before interest and tax. It also refers to PBIT, which means profit before interest and tax. Some people also use the term net profit in this area.

Overall, operating profit helps us understand how the business performs after direct costs and day-to-day running costs come out.

Where these figures appear in your financial statements

Capital expenses, operating expenses, cost of goods sold and profit figures do not all appear in the same place.

The profit and loss statement includes operating expenses, cost of goods sold, gross profit and operating profit. Accountants may also call this report the P&L, income and expenditure statement, or statement of profit or loss.

The balance sheet usually shows capital expenses separately as assets. It also shows the debts of the organisation and gives us a picture of financial strength at a specific point in time.

Our episode on Understanding Your Financial Statements: Cash Flow, Profit and Balance Sheet explains how these reports work together.

Why profit matters

Profit is one of the key measures of business performance. It helps us understand sustainability, viability and whether the business generates enough value to support its future.

This applies across sectors. A private business, arts organisation, charity or social enterprise still needs enough financial strength to survive, grow and continue its work.

As a result, profit helps build reserves, support investment, fund future activity and show whether the business model is working.

Six key questions from this episode

• What are capital expenses?
• What are operating expenses?
• What is the key difference between capital and operating expenses?
• Why does that difference matter to your business?
• How do we calculate operating expenses?
• What is the difference between cost of goods sold and operating expenses?

Practical steps for understanding financial terminology

• Write down the finance terms that appear most often in your reports.
• Separate capital expenses from day-to-day operating expenses.
• Identify which costs link directly to sales.
• Use cost of goods sold to understand gross profit.
• Use operating expenses to understand operating profit.
• Check whether each figure belongs in the profit and loss statement or balance sheet.
• Ask your accountant to explain terminology in plain English.
• Use the terms regularly so they become part of your business language.

Related episodes

• Understanding Your Financial Statements: Cash Flow, Profit and Balance Sheet
• Explaining assets and liabilities
• What Is Profit? Gross Profit and Net Profit Explained

Key takeaway

Understanding financial terminology helps us read the business story more clearly. Capital expenses, operating expenses, cost of goods sold, gross profit, operating profit and balance sheets are not just technical labels. They help us understand performance, assets, costs and profit.

Therefore, the more familiar we become with these terms, the easier it becomes to talk with advisers, review reports and make better business decisions.

If financial terminology feels confusing, start with the key terms in this episode and use the related episodes above to build confidence step by step.

Plan it, Do it, Profit.

“When we understand the language of numbers, the financial story becomes easier to read.”

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Episode Timecodes

• 00:00 – Why every sector has its own financial language
• 01:09 – The six key questions covered in this episode
• 01:29 – What capital expenses mean
• 02:33 – Fixed assets, non-current assets and CapEx explained
• 02:54 – Operating expenses and day-to-day running costs
• 04:15 – The difference between capital and operating expenses
• 04:53 – Cost of goods sold and direct costs explained
• 05:50 – Why profit matters for sustainability and performance
• 06:09 – Gross profit and operating profit explained
• 06:50 – EBIT, PBIT and net profit
• 07:12 – Profit and loss statements and balance sheets

About the Podcast

The I Hate Numbers podcast helps business owners understand accounting, tax, finance, profit, cash flow, and business planning in a practical way. We simplify financial topics so you can make better decisions and feel more confident with your numbers.

You can also watch more practical finance and tax support on the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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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.