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Working capital is the difference between a company’s current assets and its current liabilities. Assets include cash and other assets that can be converted into cash within a year, and liabilities include payroll, accounts payable, and accrued expenses. A business that maintains positive working capital has the ability to cover its short-term financial obligations as well as invest in future growth.

However, there are different types of working capital, including trade working capital. You calculate trade working capital similarly to working capital, except you only consider assets and liabilities directly associated with your daily business operations.

Read on for a closer look at trade working capital, including how it differs from working capital, how it’s calculated, and why it’s an important performance metric for business owners to know.

What Is Trade Working Capital?

To understand trade working capital, it’s important to know what working capital is. Simply defined, working capital (also known as net working capital) is a financial metric calculated as the difference between current assets and current liabilities. The formula for working capital is:

Current Assets – Current Liabilities = Working Capital

A current asset is any asset that can be converted into cash within a year, while a current liability is any amount owed to a creditor within a year. These items are listed on a business’s balance sheet.

So, what is the difference between working capital and trade working capital?

Like working capital, trade working capital is defined as the difference between a company’s current liabilities and current assets. Unlike working capital, trade working capital only considers liabilities and assets that are directly linked to day-to-day business operations.

Recommended: Insolvency vs Illiquidity

How Trade Working Capital Works

Trade working capital specifically looks at the difference between current assets and current liabilities directly associated with a company’s core operations.

As a result, the only current assets you include when using the trade working capital formula are:

•   Inventories: These are unsold products waiting to be sold.

•   Accounts receivable: This is the balance of money due to your company for goods or services delivered or used but not yet paid for by customers.

For current liabilities, the trade working capital formula only includes:

•   Accounts payable: This is the amount your company owes its vendors for inventory-related goods, such as business supplies or materials.

To calculate trade working capital, you simply add inventories and accounts receivable together and then subtract accounts payable.

Business owners, as well as investors and lenders who offer small business loans, might use this more refined version of working capital because the items listed above are the major drivers of a company’s working capital. As a result, calculating trade working capital vs. working capital might better reflect the company’s financial position.

	Trade Working Capital	Working Capital
Incorporates all current assets	X	✓
Incorporates all current liabilities	X	✓
Only includes assets directly related to day-to-day operating activities	✓	X
Only includes liabilities directly related to day-to-day operating expenses	✓	X

The key difference between trade working capital vs. working capital is what’s included in the current assets and current liabilities parts of the working capital equation.

Trade working capital only looks at assets and liabilities related to a company’s daily operations. Working capital, on the other hand, takes into account all current assets (including cash, marketable securities, accounts receivable, prepaid expenses, and inventories) and all current liabilities (including accounts payable, taxes payable, interest payable, and accrued expenses).

Like working capital, trade working capital represents the amount of excess capital a company possesses. But since trade working capital is a narrower definition of working capital, it’s seen as a more stringent measure of a company’s short-term liquidity.

Recommended: What Is a Factor Rate?

How to Calculate Trade Working Capital

Here is an example of how to calculate trade working capital using a fictional company called XYZ that manufactures boxes.

Company XYZ has $20,000 in accounts receivable associated with daily operations and $5,000 in unsold inventory. It also has $7,000 in accounts payable associated with daily operations. Therefore, its trade working capital is:

$20,000 + $5,000 – $7,000 = $18,000

Recommended: Net Present Value: How to Calculate NPV

What Trade Working Capital Indicates and Why It Matters

Like working capital, trade working capital is important to know because it tells you if your company has enough cash on hand to manage its short-term commitments. Positive trade working capital also indicates that your business has the ability to invest in new equipment and assets that may increase revenues and profits.

If, on the other hand, your company’s current liabilities exceed its current assets (in other words, you have negative trade working capital), your company may need to take on additional debt in order to avoid defaulting on its bills or, in the worst-case scenario, could be at risk of going bankrupt.

It’s important to keep in mind, however, that there is such a thing as too much trade working capital. This can be a sign that your company is not investing its extra cash strategically and may be missing out on opportunities for expansion and growth.

Recommended: What You Should Know About Short-Term Business Loans

The Takeaway

Working capital is a financial metric calculated as the difference between current assets and current liabilities. If your business has positive working capital, it means the company can pay its bills and also invest to spur business growth.

There are several types of working capital, including trade working capital. With trade working capital, you only consider current assets and current liabilities that are associated with daily business operations.

Businesses will often calculate both forms of working capital to assess their financial health at a given moment in time. If you’re in the market for any type of small business loan, lenders may look at your working capital and/or trade working capital to assess your firm’s ability to cover new debt on top of its current financial obligations.

Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.

With SoFi Small Business Loans, it's fast and easy to get the financing your business needs to thrive.

FAQ

How is trade working capital calculated?

Trade working capital is typically calculated by adding inventories and accounts receivable together, then subtracting accounts payable. This calculation focuses on the assets and liabilities directly related to a company’s day-to-day operations. A positive trade working capital generally indicates that a business has sufficient short-term resources to support operating activities.

How are trade working capital and net working capital different?

While both calculations are based on current assets minus current liabilities, there is a slight difference between trade working capital and net working capital. Trade working capital only looks at assets and liabilities related to a company’s daily operations, whereas net working capital takes all current assets and all current liabilities into account.

Is high trade working capital a good thing? When isn’t it?

It’s a good thing to have positive trade working capital because it means your company has access to enough funds to meet its day-to-day operating expenses and invest in the future. However, excessively high trade working capital isn’t necessarily a good thing. It can indicate that your company is favoring liquidity over investing in new assets and growing the business.

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Photo credit: iStock/maroke

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q226-071

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Texas has about 3.5 million small business owners who can apply for small business grants. Submitting an application and competing for Texas small business grants can help you grow your small or medium-sized enterprise in the Lone Star State.

The Texas economy has a gross domestic product (GDP) of $2.9 trillion as of 2025, growing at a rate of 2.5%. That’s the second-largest GDP in the United States out of the 50 states and the District of Columbia.

Small and medium-size firms exported about $157.9 billion worth of goods from Texas in the most recent year studied, making it the largest small business exporting state nationwide, according to the most recent U.S. Census Bureau export data.

Below, we highlight some of the top small business grants in Texas that you can explore.

Texas Small Business Grants

If you’re looking for small business grants in Texas, here are some potential options to consider.

Texas Workforce Commission (TWC) Skills for Small Business Grant

Program description: This program provides small business owners with workforce training funds that can help employees learn new skills.

•   Incentive: Small businesses can receive workforce training funds covering up to $2,000 of eligible tuition costs in a 12-month period for a new employee and up to $1,000 in a 12-month period for an existing employee who learns new skills in a continuing education course.

•   General requirements: Here are some of the general requirements for this grant:

◦   Be a small business owner based in Texas

◦   Employ at least one full-time employee and not more than 99

◦   Pay the prevailing wage in your local labor market

◦   Use the funding to train at least one full-time employee

◦   All training must be provided by a public community or technical college

◦   Self-employed individuals aren’t eligible for this grant program

•   How to apply: Visit the TWC website to apply.

State Trade Expansion Program (STEP) Grant

•   Program description: The State Trade Expansion Program (STEP) is funded by the SBA and administered through the Texas Governor’s Office. It provides reimbursement grants that can help you export your goods and services from the Lone Star State to foreign markets.

•   Incentive: Receive reimbursement for eligible business expenses, including your expenses of advertising overseas, attending international trade shows, and market research, among other export-related expenses.

•   General requirements: Here are some of the general requirements for this grant:

◦   Operate a Texas-based small company with a for-profit business structure

◦   Be in good standing with the Texas Comptroller of Public Accounts

◦   Have at least one year of business experience

◦   Understand how exporting works and the cost of doing business with foreign buyers

◦   Have a Federal Identification Number tied to a Texas address

◦   Have a product or service that’s manufactured, produced, processed, or value-added in Texas

◦   Be new to exporting or expanding your exports to new markets abroad

•   How to apply: Check the SBA website for details.

SAGE Storefront Grant

•   Program description: The San Antonio for Growth on the East Side (SAGE) Storefront Grant provides funding and support for small businesses in San Antonio’s Eastside to improve their exterior spaces.

•   Incentive: Receive up to $10,000 in grant funding for exterior renovations, façade upgrades, signage, lighting, and more.

•   General requirements: Here are some of the general requirements for this grant:

◦   Be a for-profit small business or property owner

◦   Be located in the Eastside Promise Zone or surrounding eligible areas

◦   Demonstrate financial need or plans for storefront improvement

•   How to apply: Visit the SAGE website to apply.

City of Austin’s Zero Waste Business Rebate

•   Program description: The City of Austin offers rebates for eligible businesses that improve their waste reduction and diversion practices.

•   Incentive: Receive up to $3,000 reimbursement for reducing waste beyond the minimum requirements of Austin’s Universal Recycling Ordinance.

•   General requirements: Here are some of the general requirements for this rebate program:

◦   Business is based within the City of Austin’s full-purpose jurisdiction

◦   Business owner provides on-site recycling services to tenants and employees on company premises as required by City of Austin Code of Ordinances

◦   Business is in compliance with the municipal Austin City Code

◦   All tax accounts are in good standing

•   How to apply: Access the rebate application via the City of Austin website.

City of Rosenberg Business Improvement Grant Program

•   Program description: The Rosenberg Development Corporation (RDC) offers partial reimbursements to eligible businesses that make capital improvements to their Rosenberg commercial properties.

•   Incentive: Receive up to $10K reimbursement for implementing a qualifying project, including façade improvements, landscaping, and demolition of abandoned signs and structures.

•   General requirements: Here are some of the general requirements for this grant program:

◦   Business is based within Rosenberg city limits in Fort Bend County, Texas

◦   Entity is structured as a for-profit business

◦   Business has no outstanding financial obligations to the City of Rosenberg

◦   Business and owner have no active lawsuits against the City of Rosenberg

◦   Business facilities are not used for residential purposes

•   How to apply: You can obtain an application via the City of Rosenberg website.

Recommended: Business vs Personal Loans: What’s the Difference?

National Grant Options for Texas Businesses

Texas businesses have a wealth of national grant options available to support their growth, innovation, and operational needs. These grants, offered by federal agencies, nonprofits, and private organizations, provide crucial funding without the burden of repayment.

1.    National Institute of Standards and Technology (NIST) Grants:

◦   Description: NIST provides grants to support small businesses in developing and commercializing innovative technologies.

◦   Benefits: Funding is available for research and development, technology transfer, and commercialization efforts.

◦   Eligibility: Funding is open to U.S. small businesses engaged in technology innovation.

2.    Patagonia Corporate Grants Program:

◦   Description: Patagonia provides grants to small businesses and nonprofit organizations focused on environmental conservation and sustainability.

◦   Benefits: Grants typically range from $5,000-$20,000.

◦   Eligibility: Grants are open to businesses and nonprofits in the U.S. working on environmental initiatives but currently operate on an invitation-only basis.

By exploring these national grant options, Texas businesses can access vital financial resources to drive innovation, support growth, and achieve long-term success.

Who Provides Small Business Grants in Texas?

Municipal, county, and state governments in Texas may offer small business grants in the Lone Star State. Corporate entities may also provide financial assistance to Texas establishments.

You can compare small business grants in Texas with similar programs in other states, such as:

•   California small business grants

•   Florida small business grants

•   New York small business grants

Do You Have to Pay Back a Small Business Grant?

A small business grant typically comes with terms and conditions, and you may be responsible for paying back the grant if you violate those terms. In general, small and midsized business owners aren’t required to pay back a small business grant absent any violations.

You typically have to sign a funding agreement to accept a small business grant. As mentioned above, the grant may come with certain conditions. Using the grant for an illegitimate purpose may violate the agreement and require business owners to pay back the grant.

Small business grants may require you to spend the money by a certain date. You may also have to provide proof of payment and a written statement detailing how you’ve spent the grant.

Who Is Eligible for Small Business Grants in Texas?

Local business owners or operators of an enterprise with fewer than 500 employees may be eligible for small business grants in Texas.

The U.S. Small Business Administration’s Office of Advocacy generally defines a small business as an independent business having fewer than 500 employees. A small business, including freelancers, may be eligible for small business grants.

What Industries Does Texas Support With Grants?

Texas offers a variety of grants supporting the following industries:

•   Manufacturing

•   Food services and drinking places

•   Real estate

•   Restaurants and other eating places

•   Retail trade (store and nonstore retailers)

Texas Resources for SMB Owners Looking for Funding

Here are some resources for small and medium-sized businesses looking for funding in the Lone Star State.

Texas Small Business Development Center (SBDC) Network

The Texas SBDC network can provide Texas small business owners with the following services:

•   In-person business training and webinar events

•   Access to market research reports

•   Professional business advising at no cost

SBA District Offices in Texas

The U.S. Small Business Administration (SBA) is a federal agency that provides resources and support to small business owners. The SBA has six district offices in Texas:

•   SBA Dallas / Fort Worth District Office. This SBA district serves 72 counties in northeastern Texas. It’s based in Euless.

•   SBA El Paso District Office. This SBA district serves nine counties in western Texas. It’s based in El Paso.

•   SBA Houston District Office. This SBA district serves 32 counties in southeastern Texas. It’s based in Houston.

•   SBA Lower Rio Grande Valley District Office. This SBA district serves 14 counties in southern Texas. It’s based in Harlingen.

•   SBA San Antonio District Office. This SBA district serves 55 counties in south central Texas. It’s based in San Antonio.

•   SBA West Texas District Office. This SBA district serves 71 counties in western Texas. It’s based in Lubbock.

Alternative Funding Sources for Small Businesses in Texas

Here are some alternative funding sources for small businesses in Texas:

Texas Small Business Credit Initiative (TSBCI)

The Texas Small Business Credit Initiative is a federally funded program for small business owners in the Lone Star State. Federal law — the American Rescue Plan Act of 2021 — allocates more than $472 million to the TSBCI.

Here’s how Texas plans to use the funding:

•   TSBCI Loan Guarantee Program — $354 million. This program makes it easier for Texas startups to qualify for small business loans by providing guarantees of up to 80% of unpaid principal on enrolled loans.

•   TSBCI Capital Access Program — $118 million. This program uses TSBCI matching funds to support portfolio insurance on small business loans. This can make it easier for socially and economically disadvantaged individuals to access small business funding.

Texas Microloan Lenders

Community-based nonprofits may offer microloans of up to $50,000 to small business owners in Texas, including microloans for women-owned small businesses. In general, microloans can range from $500-$50,000 and may be available to startups.

Recommended: 6 Step Guide to Getting a Small Business Loan

Texas Small Business Loans From Private Lenders

Banks, credit unions, and private lenders may offer different types of small business loans to Texas business owners. Crowdfunding and peer-to-peer lending are other potential sources of funding.

Here are some of the funding products you may consider depending on your needs:

•   Commercial real estate loans

•   Equipment financing

•   Small business loans for startups

•   Working capital lines of credit

Recommended: Small Business Loans in Texas

The Takeaway

Texas is full of ways for small business owners to find funding. Look into the variety of grants available from state and local governments, such as those for employee training or building improvements. Don’t forget to check national grant programs, too. Since grants usually don’t need to be paid back, they’re a great resource. If a grant isn’t the right fit, explore alternatives such as microloans, credit initiatives, or small business loans from private lenders. The key is to explore all your options to help your business grow.

Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.

With SoFi Small Business Loans, it's fast and easy to get the financing your business needs to thrive.

FAQ

How do you get a small business grant in Texas?

You can apply for Texas small business grants, but there’s no guarantee you’ll get approved for one. You may have to submit a grant application as a qualified small business owner to be considered for a small business grant in Texas.

How hard is it to get a business loan in Texas?

You may have difficulty getting a small business loan in Texas if you have bad credit or insufficient business experience. You generally have to pay back business loans with interest.

What is the easiest SBA loan to get approved for?

There’s no guarantee you’ll get approved for any SBA loan, but SBA microloans may be one of the easier ones to get if you’re a new business owner. Startups may be eligible for SBA microloans of up to $50K. If you’re looking for a streamlined application process, SBA Express working capital loans are an option you may consider.

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Photo credit: iStock/supersizer

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOSMB-Q226-066

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A factor rate expresses the percentage of a loan amount that you need to pay back. It’s commonly used in commercial financing offers (such as sales- or revenue-based financing) and merchant cash advances. Factor rates are typically expressed as a decimal figure between 1.1 and 1.5.

Below, you’ll learn more about what a factor rate is, how it operates, and how nonbank finance companies typically use factor rates to make money.

Factor Rates Defined

Factor rates are typically used by nonbank finance companies to calculate some or all of your total costs on nontraditional commercial funding.

A factor rate is typically used in the following sales-based financing or revenue-based financing products:

•   Inventory financing

•   Invoice factoring

•   Merchant cash advance (MCA)

•   Purchase order financing

Factor rates on a merchant cash advance typically range from 1.1-1.5, and the rate is used to calculate your repayment costs (not including any additional fees).

Factor Rates vs APR

It’s worth noting that MCAs and other sales-based financing products are typically expensive when compared with traditional small business loans. That’s because the total costs of a merchant cash advance can include a factor rate and additional fees that would typically represent a high annual percentage rate (APR) if it were a traditional bank loan.

With a merchant cash advance, reports indicate that you can wind up with an APR of close to or even more than 100.00%.

The APR on a small business microloan, meanwhile, can have APRs starting at 7.00% or 8.00%. Community-based microlenders may offer microloans of up to $50K.

Recommended: What Is Trade Working Capital?

How Do You Calculate a Factor Rate?

To calculate the total cost of the loan with a factor rate, simply multiply the loan amount by the factor rate.

Here’s an example of a factor rate in action: Say a business owner takes out a merchant cash advance (MCA) for $10,000, and the factor rate is 1.2.

$10,000 × 1.2 = $12,000

So $12,000 is the total amount of money owed on the merchant cash advance if the provider doesn’t charge additional fees. Some MCA providers may charge additional fees on top of the factor rate.

An MCA is a common type of sales-based financing that charges a factor rate vs. a short-term business loan that charges interest.

What Lenders Look at to Determine a Factor Rate

As with a lender who issues interest rate loans, a lender who offers sales-based financing with a factor rate generally also wants to know that borrowers will be able to pay the financing back. Even though taking payments directly from a merchant’s sales provides some security to the lender, if a borrower is perceived as more risky, it might be offered a higher factor rate.

Every lender has its own requirements, of course. But across the board, in order to determine your factor rate, a lender may ask to see:

•   Credit card processing statements: The lender will want to see proof that you have credit card sales large enough for it to deduct payments from them.

•   Bank statements: A lender may want a sense of your business’s financial situation and request some of your recent bank statements.

•   Time in business: Typically, lenders prefer to lend to businesses that have been operating for at least a year.

•   Business tax return: This will allow the lender to assess the financial health of your business.

Lenders may consider other factors when determining your factor rate, but these are among the likely components.

Factor Rate vs Interest Rates

Although it’s similar in some ways, a factor rate is not the same thing as an interest rate. As mentioned earlier, a factor rate is a percentage of a commercial financing offer, and the rate is typically expressed as a decimal figure between 1.1 and 1.5. Sales-based financers, including merchant cash advance providers, can make money by charging a factor rate.

Factor rate example: A $10,000 MCA with a 1.2 factor rate would cost at least $12,000. The factor rate doesn’t necessarily tell you the total cost of the MCA because MCA providers can charge additional fees on top of the factor rate.

An interest rate is a finance charge typically expressed as an annual percentage of a borrower’s outstanding principal. State usury laws can limit the maximum interest rate that lenders charge on traditional loan products. You can typically minimize your total interest charges by paying a loan off early.

Interest rate example: A $10,000 microloan with a 7.00% interest rate, five-year repayment plan, and no additional fees would cost about $11,880 after 60 months. The total borrowing costs would be lower if there’s no prepayment penalty and you pay the loan off early.

Here are some points to keep in mind:

•   The interest rate doesn’t necessarily tell you the total cost of a loan because lenders can charge additional fees on top of the interest rate charges.

•   A merchant cash advance is a sales-based financing solution that typically charges a factor rate, whereas traditional loans typically charge interest.

•   An APR takes the interest rate and upfront fees into account, so APR can give you a better idea of a loan’s total cost than the interest rate alone.

Recommended: Guide to Variable Costing Income Statements

Pros and Cons of Factor Rates

Here are some pros and cons of factor rates:

Pros of Factor Rates

•   Factor rates make it relatively easy to calculate costs upfront.

•   Factor rate products, such as merchant cash advances, typically have fast funding times.

•   Factor rate products may have less rigorous credit score requirements than other forms of financing.

Cons of Factor Rates

•   Factor rate charges cannot be minimized via prepayment.

•   Factor rates are a nontraditional commercial financing term.

•   They can translate into APRs of 50.00%, 100.00%, or higher.

Recommended: What Is the Minimum Credit Score for a Business Loan?

The Takeaway

A factor rate is the percentage of the loan amount that a borrower must pay to pay back a loan, expressed as a decimal. It’s a nontraditional financing term typically used by merchant cash advance providers. Nonbank finance companies may charge a factor rate along with additional fees.

Typically, loans that come with factor rates end up being more expensive than traditional small business loans.

Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.

With SoFi Small Business Loans, it's fast and easy to get the financing your business needs to thrive.

FAQ

What is a factor rate?

A factor rate is a fee structure used in merchant cash advances and some short-term business loans. It’s expressed as a decimal, such as 1.2 or 1.4, rather than a percentage, and determines the total repayment amount.

How is a factor rate calculated?

To calculate the total repayment, multiply the loan amount by the factor rate. For instance, a $10,000 loan with a factor rate of 1.2 would require repayment of $12,000. Factor rates do not accrue over time, and the total repayment amount is fixed from the start, making it easier to understand the full cost of borrowing.

How do factor rates work?

Factor rates are fees that lenders charge for certain types of business loans, mainly merchant cash advances. They are expressed as a decimal rather than a percentage and are multiplied by the total loan amount to produce a flat fee, which means that the loan doesn’t grow over time. If you have a loan for $10,000, for example, and a factor rate of 1.3, you would multiply those two numbers together for a total of $13,000.

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Photo credit: iStock/FG Trade Latin

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q226-068

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A variable cost is an expense that rises and falls in proportion to how much your business produces or sells. A variable costing income statement is a type of income statement in which you subtract variable expenses from total sales revenue to arrive at a separate line item called contribution margin. Contribution margin is the money left over from sales after you have paid all variable production expenses. From there, you subtract fixed expenses, such as rent and salaries, to get your net income, or profit.

Read on for a closer look at variable costing income statements, including how they differ from traditional income statements, what they can tell you about your small business, and the pros and cons of preparing this type of income statement.

What Is Variable Costing?

Your business incurs both variable and fixed costs. Variable costs fluctuate depending on the number of products you produce or sell, whereas fixed costs stay the same regardless of how much you produce or sell.

Variable costing is a method of cost accounting that excludes fixed manufacturing expenses from the cost of making products. It differs from absorption costing, in which you allocate fixed overhead costs to products produced.

Variable production costs include the cost of materials, packaging, and supplies. In some cases, variable costs might also include overhead costs that vary based on the number of products sold, such as commissions paid to salespeople. To calculate your total variable production expenses, you add your total variable cost of goods sold to your total variable selling expenses.

While the Generally Accepted Accounting Principles (GAAP) do not allow the use of variable costing in financial reporting, business owners and managers will often use the variable costing method to calculate the contribution margin, which is the metric that tells you your break-even point, or how many units need to be sold before you start earning a profit.

Recommended: Break-Even Analysis: How to Calculate and Examples

What Are Variable Costing Income Statements?

A variable costing income statement is a financial report in which you subtract variable expenses from revenue, resulting in a contribution margin. From there, you subtract all fixed expenses to arrive at the net profit (or loss) for the accounting period.

Variable costing income statements differ from traditional income statements in that all fixed production costs are listed lower in the statement, after the contribution margin. Fixed overhead is regarded as a period cost and is charged against revenue in the period it is incurred.

Two other key differences:

•   All variable selling and administrative expenses are combined with variable production costs to calculate contribution margin.

•   Gross margin (which includes both variable and fixed production costs in the cost of goods sold) is replaced by the contribution margin (which only includes variable costs in the cost of goods sold).

Under both a variable costing income statement and a normal income statement, the net profit or loss will be the same.

Recommended: Commercial Equity Line of Credit

Examples of Variable Costing Income Statements

Here are two examples of how variable costing statements are used across different industries.

Example 1: Manufacturing Company

XYZ Manufacturing produces custom furniture. In a given month, the company sells 500 units at $200 each, resulting in $100,000 in sales. The variable costs include:

•   Direct materials: $50 per unit

•   Direct labor: $30 per unit

•   Variable manufacturing overhead: $10 per unit

Total variable costs per unit are $90. The total variable cost for 500 units is $45,000. The contribution margin is calculated as:

Contribution Margin = Sales − Variable Costs = $100,000 − $45,000 = $55,000

Fixed costs for the period, including rent, salaries, and fixed overhead, are $30,000. The net operating income under variable costing is:

Net Operating Income = Contribution Margin − Fixed Costs = $55,000 − $30,000 = $25,000

Example 2: Service Company

ABC Consulting provides marketing services. In a month, the company earns $80,000 in revenue. Variable costs include:

•   Consultant fees: $20,000

•   Marketing materials: $5,000

Total variable costs are $25,000. The contribution margin is:

Contribution Margin = Revenue − Variable Costs = $80,000 − $25,000 = $55,000

Fixed costs, such as office rent and administrative salaries, total $20,000. The net operating income is:

Net Operating Income = Contribution Margin − Fixed Costs = $55,000 − $20,000 = $35,000

These examples illustrate how variable costing income statements provide a detailed view of profitability by separating variable and fixed costs.

How to Create a Variable Costing Income Statement

Creating a variable costing income statement involves several key steps to distinguish between variable and fixed costs. Here’s a step-by-step guide:

1.    Gather financial dataStart by collecting all relevant financial data for the period, including sales revenue, variable costs, and fixed costs. Ensure you have detailed records of all costs associated with production and operations.

2.    Identify and calculate variable costsVariable costs are expenses that fluctuate with production levels. Common variable costs include:

◦   Direct materials: Costs of raw materials used in production

◦   Direct labor: Wages paid to workers directly involved in manufacturing

◦   Variable manufacturing overhead: Costs that vary with production volume, such as utilities for manufacturing facilities

◦   Sales commissions: Payments to sales staff based on sales performance

Sum all variable costs for the period. This will give you the total variable costs, which will be subtracted from sales revenue to determine the contribution margin.

3.    Compute the contribution margin

The contribution margin is the difference between sales revenue and total variable costs. It indicates how much revenue is available to cover fixed costs and contribute to profit.

Contribution Margin = Sales Revenue − Total Variable Costs

4.    Identify fixed costs

Fixed costs are expenses that remain constant regardless of production levels. These typically include:

◦   Rent: Costs for business premises

◦   Salaries: Fixed wages for administrative and management staff

◦   Depreciation: Allocation of the cost of tangible assets over their useful lives

◦   Fixed manufacturing overhead: Costs such as insurance and property taxes

5.    Calculate net operating incomeSubtract total fixed costs from the contribution margin to determine net operating income:

Net Operating Income = Contribution Margin − Total Fixed Costs

6.    Format the income statementPresent the data in a clear, structured format. A typical variable costing income statement includes:

•   Sales revenue

•   Less: variable costs

◦   Direct materials

◦   Direct labor

◦   Variable manufacturing overhead

◦   Sales commissions

•   Contribution margin

•   Less: fixed costs

◦   Rent

◦   Salaries

◦   Depreciation

◦   Fixed manufacturing overhead

•   Net operating income

Pros and Cons of Variable Costing Income Statements

Normal Income Statements vs Variable Costing Income Statements

	Normal Income Statement	Variable Costing Income Statement
Accounting method	Absorption costing	Variable costing
How overhead costs are treated	Per-unit basis	Periodic basis
Type of margin calculated	Gross margin	Contribution margin
GAAP compliant?	Yes	No

Both variable costing income statements and normal income statements report a company’s profit or loss for a specific accounting period. However, they arrive at a company’s “bottom line” in different ways.

Traditional income statements use absorption costing, which allocates all manufacturing costs to finished goods. Fixed overhead costs are spread out among all goods produced and added to the total cost of producing each good.

By contrast, variable costing income statements use variable costing. With this approach, only variable costs are included in the cost of goods sold. Overhead costs are considered on a periodic basis rather than a per-unit basis and listed lower in the statement.

Another key difference is that a standard income statement calculates a gross margin, while a variable costing income statement calculates a contribution margin.

Recommended: How to Read Financial Statements

Other Kinds of Income Statements

All income statements report a company’s profit or loss. However, they can be formatted in different ways. Here’s a look at two other types of income statements.

Contribution Margin

Just like the variable costing income statement, a contribution margin income statement only includes variable expenses in the cost of goods sold and pushes fixed production costs lower down in the statement to make it easier to understand the contribution margin on sales.

Traditional

A traditional income statement focuses on the revenue, expenses, gains, and losses of a company during a particular period. This format is GAAP-compliant and uses absorption costing, which captures all costs (fixed and variable) associated with manufacturing a particular product.

Recommended: How to Read a Profit & Loss Statement

The Takeaway

A variable costing income statement is a financial report prepared using the variable costing method, in which you only deduct variable expenses from total sales for a specific period to come up with a contribution margin. The statement then deducts fixed costs, which it considers period costs.

Variable costing income statements are typically prepared for internal use to help inform decisions about pricing and cost management. However, this type of income statement is not GAAP-compliant. If you decide to seek outside funding through an investor or a small business loan, you will likely need to prepare a traditional income statement.

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FAQ

What are the advantages of using variable costing when preparing income statements?

The advantages of financial statements prepared under variable costing include helping you conduct a break-even analysis to show how much your company must sell at a certain price before it shows a manufacturing profit. They also provide a more accurate picture of your cash flow, which can be particularly important for small businesses with tight margins.

What exactly is variable costing? What are variable costs?

Variable costing is an accounting method for calculating production expenses where only variable costs are included in the product cost. Variable costs are those that rise and fall in proportion with the amount of goods a company produces or sells. They include direct labor costs, direct raw material costs, and variable manufacturing overhead.

Which costs are treated as product costs under variable costing?

Under variable costing, only those production costs that vary directly with output are treated as product costs. These include direct labor costs, direct raw material costs, and variable manufacturing overhead.

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Photo credit: iStock/staticnak1983

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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Net operating income (NOI) and earnings before interest, tax, depreciation, and amortization (EBITDA) are similar metrics used to measure a company’s profitability from its core business operations. Different industries choose different metrics. NOI is generally used in real estate to evaluate income-producing properties, whereas EBITDA is most often used to measure how efficiently a company is operating and how it compares to competitors.

Here’s a closer look at NOI vs. EBITDA, how each one is calculated, their similarities and differences, and why they are important.

What Is Net Operating Income?

Net operating income, or NOI, is a measurement used to determine the profitability of an income-producing property. NOI determines the revenue of a property by subtracting gross operating expenses from gross income. While NOI is most frequently used in the real estate industry, it can be used by any company that earns income from a property.

With NOI, a property’s gross income is everything it earns minus any losses due to vacancies.

As a rule of thumb, an expense is considered an operating expense if not spending money on that cost would jeopardize the asset’s ability to continue producing income. Operating expenses commonly include property taxes, vendor and supplier costs, maintenance and repair, insurance, utilities, licenses, supplies, and overhead costs, such as expenses for accounting, attorneys, and advertising.

Since income taxes, loan interest and principal payments, capital expenditures (money spent on improvements or repairs), and amortization and depreciation (the gradual write-off of long-term assets) do not impact the potential of a real estate investment to make money, they are not included in NOI.

A lender may look at a company’s NOI if it’s applying for a small business loan, such as a commercial real estate loan.

How to Calculate Net Operating Income

NOI measures a property’s ability to generate a profit from its operations. The NOI formula is:

NOI = Gross Operating Income – Operating Expenses

Pros and Cons of Using NOI

While NOI can give potential investors and lenders a good indication of how profitable a property will be, it also has some drawbacks. Here’s a look at the pros and cons of using NOI.

Pros of NOI	Cons of NOI
Helps determine the initial value of a potential investment property	Can sometimes be inaccurate, as future rents and cash flow can be difficult to predict
Gives investors a good idea of how much revenue they can expect to make	May vary depending on how the property is managed
Shows lenders if the rental property is a safe or risky investment	Not universal because investors use slightly different calculation methods

Recommended: Annual Revenue Meaning and Calculation

What Is EBITDA?

EBITDA (earnings before interest, taxes, depreciation, and amortization) is used to calculate the earnings that a business has generated from its core operations.

To calculate a company’s annual earnings, EBITDA factors in the cost of goods sold, general and administrative expenses, and other operating expenses. However, it doesn’t subtract costs that are not directly related to the company’s operations, namely interest paid on debt, amortization and depreciation expenses, and income taxes on business revenue. The reason is that these costs are outside of management’s operational control.

By adding these values back to net income (which is gross business income minus all business expenses), many analysts believe that EBITDA can be a better measure of company performance because it shows earnings before the influence of accounting and financial deductions. EBITDA can also be useful for comparing firms with different sizes, structures, taxes, and depreciation.

Your company’s EBITDA may be calculated by a potential investor or by a creditor when you’re applying for a business loan because it provides a snapshot of how well your company will be able to pay its bills and maintain or increase net income.

Recommended: How to Calculate EBITDA

How to Calculate EBITDA

The two most commonly used ways to calculate EBITDA include:

Option 1: Start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation, and amortization.

Net income + Taxes Owed + Interest + Depreciation + Amortization = EBITDA

Option 2: Start with operating income (also referred to as operating profit or earnings before interest and taxes (EBIT)), and add back depreciation and amortization.

Operating Income + Depreciation + Amortization = EBITDA

Recommended: Business Cash Management, Explained

Pros and Cons of Using EBITDA

Pros of using EBITDA include:

•   It offers a clear view of operational performance by excluding nonoperational expenses, including interest, taxes, depreciation, and amortization.

•   EBITDA simplifies comparison across companies with different capital structures.

•   It helps assess cash flow potential and operational efficiency.

Cons of using EBITDA include:

•   It can obscure important financial costs, such as debt and capital expenditures, leading to an incomplete financial picture.

•   EBITDA may overstate profitability by ignoring noncash expenses.

•   Investors might be misled about a company’s long-term financial health if focusing solely on EBITDA.

NOI vs EBITDA Compared

NOI and EBITDA have some similarities, but also a couple of key differences. Here’s how the two formulas compare.

Similarities

Both NOI and EBITDA measure the profitability of a business or property without including income taxes, the cost of loans, amortization, or depreciation as expenses. NOI is essentially EBITDA within a real estate context. By stripping away incidentals, both NOI and EBITDA level the playing field, which makes them useful for comparing different properties and businesses.

Banks will often use NOI or EBITDA (depending on a borrower’s industry) before giving the green light on different types of business loans. These metrics help them determine whether or not the business will have the cash flow to pay back the loan.

Recommended: What Is the Difference Between EBIT and EBITDA?

Differences

NOI is primarily used to evaluate the profitability of an investment in a commercial or residential real estate property. EBITDA, on the other hand, is mainly used to evaluate the profitability of a company. As a result, NOI takes into account lost revenues from vacancies, whereas EBITDA does not.

	EBITDA	NOI
Loan size	Larger	Smaller
Evaluates the profitability of a business	✓	✓
Accounts for lost revenues from vacancies	X	✓
Excludes income taxes	✓	✓
Excludes the cost of loans	✓	✓
Excludes amortization and depreciation expenses	✓	✓

Recommended: What You Should Know About Short-Term Business Loans

Example of EBITDA vs Net Operating Income

Let’s look at how NOI and EBITDA compare when they’re applied to a business.

Let’s say you’re considering purchasing a multi-tenant apartment building. You know the property already brings in gross revenues of $1.5 million. Operating expenses are $500,000, and other expenses include:

•   Lost revenues from vacancies: $50,000

•   Interest: $4,000

•   Tax: $100,000

•   Depreciation: $50,000

•   Amortization: $25,000

Here’s how to calculate the property’s NOI:

NOI = Gross Revenues ($1.5 million – $50,000 in Vacancies) – Operating Expenses ($500,000)

NOI = $950,000

While EBITDA is not typically used to calculate profits of real estate, let’s look at what the building’s EBITDA would be for the sake of comparison.

To calculate EBITDA, you first need to figure out net income, which is gross revenues minus operating expenses:

Gross Revenues ($1.5 million) – Operating Expenses ($679,000) = Net Income ($821,000)

EBITDA = Net Income ($821,000) + Taxes Owed ($100,000) + Interest ($4,000) + Depreciation ($50,000) + Amortization ($25,000)

EBITDA = $1,000,000

The difference between the two — $50,000 — represents the lost income to vacancies, which is not factored into EBITDA.

Recommended: Net Present Value: How to Calculate NPV

Obtaining Small Business Financing

Both NOI and EBITDA calculate a company’s profitability by subtracting operating expenses from revenues. In addition, both metrics exclude income taxes, debt expenses, depreciation, and amortization, since these expenses are not related to the company’s core operations.

The key difference between NOI and EBITDA is that NOI is used for real estate and EBITDA is used for general businesses.

When it comes to small business loans, a lender will likely look at your NOI or EBITDA (depending on your company’s industry), along with other key financial metrics, to see whether you have enough positive cash flow to comfortably make payments on the loan.

Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.

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FAQ

Does net operating income mean the same thing as EBITDA?

Net operating income (NOI) and earnings before interest, tax, depreciation, and amortization (EBITDA) are similar ways to calculate a business’s profitability. However, NOI is used for an income-generating property, and EBITDA is used for a business.

Should EBITDA or NOI be higher?

Net operating income (NOI) is used for commercial real estate and earnings before interest, tax, depreciation, and amortization (EBITDA) is used for operating companies. However, if you used EBITDA and NOI to evaluate the same income-producing property, EBITDA would be higher because it does not account for lost income due to vacancies.

Can you have a negative EBITDA?

Yes, companies can have negative earnings before interest, tax, depreciation, and amortization (EBITDA). It implies that they have poor cash flow and that operating expenses exceed revenues.

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Photo credit: iStock/LumiNola

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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