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Writer's pictureNarendra Sharma

Basic Financial Terms: Definitions & Statements


Accounts payable (A/P):

Money owed by a company to suppliers.


Accounts receivable (A/R):

Money owed to a company for goods or services sold.


Accrual:

An amount incurred as an expense in a given accounting period but not paid by the end of that period.


Accrual accounting:

An accounting method whereby revenue and expenses are booked when they are incurred, regardless of when they are actually received or paid. Revenue is recognized in the time period when the goods or services are delivered; expenses are recognized in the same period as their associated revenues.


Acid-test ratio:

A measure of a company's ability to meet its short-term obligations, also known as the acid test. To calculate the quick ratio, divide cash, receivables, and marketable securities by current liabilities.


Allocation:

The process of dividing costs in a certain category among several cost centers, typically on the basic of usage. For example, corporate overhead such as rent and utilities may be allocated to departments according to the number of square feet they occupy.


Amortization:

A charge on the income statement reflecting a portion of the cost of an intangible asset such as a patent.


Assets:

The economic resources of a company. Assets include cash, accounts receivable, inventories, land, buildings, vehicles, machinery, equipment, and other investments.


Asset turnover:

A measure of how efficiently a company uses its assets. To calculate, divide sales by assets. In general, the higher the number, the better.


Balance Sheet:

A document summarizing a company's financial position- its assets, liabilities, and owners' equity- at a specific point in time. According to the fundamental equation of the balance sheet, a company's assets equal its liabilities plus owners' equity.


Banker's ratio:

A comparison of a company's current assets with its current liabilities. To calculate, divide total current assets by total current liabilities.


Book value:

The value at which an asset is carried on a balance sheet. The book value of a new asset is its purchase price, but that figure is reduced each year for depreciation. So the asset's book value at any point in time is its cost minus accumulated depreciation.


Bottom-up budgeting:

A process whereby managers put together budgets that they feel will best meet the needs and goals of their respective departments or units. These budgets are "rolled up" to create an overall company budget, which is then adjusted, with requests for changes being sent back down to the individual departments.


Breakeven:

The volume at which the total contribution from a product line equals total fixed costs. To calculate it, subtract the variable cost per unit from the selling price to determine the unit contribution; then divide total fixed costs by the unit contribution. Breakeven on an investment is the point when the net cash received from the investment equals its cost.


Capital expenditure or capital investment:

Payment to acquire or improve a capital asset.


Cash-based accounting:

The recording of revenue and expenses when cash actually changes hands. This approach is seldom used except by very small companies.


Cash flow statement:

A statement showing where the company's cash comes from and where it goes.


Contributed capital:

Capital funds received in exchange for stock.


Contribution:

In product cost analysis, unit revenue minus variable cost per unit; the sum of money available to contribute to fixed costs.


Cost of capital:

The percentage rate a company must pay investors or lenders in return for its capital funding. Companies calculate their weighted average cost of capital by raking into account factors such as the average interest rate on their debt, the expected rate of return on their equity, and their tax rate.


Cost of goods sold (COGS):

Costs directly associated with making a product.


Cost of services (COS):

Costs directly associated with delivering a service.


Current Assets:

Those assets that are most easily converted into cash, including cash on hand, accounts receivable, and inventory.


Current ratio:

A comparison of a company's current assets with its current liabilities. To calculate, divide total current assets by total current liabilities.


Days payable outstanding:

A measure indicating how many days it takes, on average, for a company to pay its suppliers. To calculate, divide accounts payable by cost of goods sold per day.


Day sales outstanding:

A measure indicating how long it takes, on average, for a company to collect its receivables. To calculate, divide accounts receivable by revenue per day.


Debt:

Money owed to a creditor.


Debt-to-equity ratio:

A comparison of a company's outstanding loans to its owners' equity. To calculate the debt-to-equity ratio, divide total liabilities by owners' equity.


Depreciation:

A charge on the income statement representing a portion of the cost of a tangible asset such as a building or a machine. The cost of such assets is charged over estimated useful life.


Direct costs:

Costs directly attributable to the manufacture of a product or the delivery of a service- for example, the cost of plastic for a bottle manufacturer or the cost of a service technician's time for a copier service company.


Dividend:

A payment (usually issued quarterly) to the stockholders of a company, as a return on their investment.


Earning before interest and taxes (EBIT):

The sum remaining after all operating costs are subtracted from revenue. Also known as earnings before interest and taxes (EBIT).


Earning per share (EPS):

A company's net income divided by the number of shares outstanding. One of the most common indicators of a public company's financial performance.


Earnings statement:

A report showing a company's revenue, expenses, and profit over a period of time, usually a month, a quarter, or a year. The income statement is also known as a profit-and-loss statement (P&L), a statement of operations, and a statement of earnings.


Economic value Added (EVA):

Net income minus a charge for the cost of a company's capital.


Efficiency ratio:

Financial measures that link various income statement and balance sheet figures to gauge a company's operating efficiency. Examples include asset turnover, days sales outstanding, days payable outstanding, and inventory days.


Equity:

The vale of a company's assets minus its liabilities. On a balance sheet, equity is referred to as shareholders' equity or owners' equity.


Financial leverage:

The extent to which a company's assets are financed by debt. A company that has a high debt-to-equity ratio (by industry standards) is said to be highly leveraged.


Financial statements:

Reports of a company's financial performance. The three fundamental statements are the income statement, the balance sheet, and the cash flow statement; they present related information but provide different perspectives on performance.


Fiscal period or reporting period:

An accounting time period (usually a month, a quarter, or a year) at the end of which the books are closed and profit or loss is determined.


Fixed assets:

Asset that are difficult to convert to cash, such as buildings and equipment.


Fixed costs:

Costs that remain constant in the short run regardless of sales volume; they include administrative salaries, interest, rent, and insurance.


Generally accepted accounting principles (GAAP):

The rules and conventions that accountants in the United States follow when recording and summarizing transactions and preparing financial statements.


Grass margin:

Gross profit as a percentage of revenue.


Gross profit:

The sum remaining when COGS is subtracted from revenue.


Growth:

An increase in the company's revenue, profits, or owners' equity.


Hurdle rate:

A company's minimum required rate of return on its investments.


Income statement:

A report showing a company's revenue, expenses, and profit over a period of time, usually a month, a quarter, or a year. The income statement is also known as a profit-and-loss statement (P&L), a statement of operations, and a statement of earnings.


Indirect costs:

Costs not directly attributable to the manufacture of a product or the provision of a service.


Interest coverage:

An indicator of company's margin of safety on its interest costs- specifically, how many times over the company could make its interest payments out of current operating profits. To calculate interest coverage, divide EBIT by interest expense.


Internal rate of return (IRR):

The rate at which the net present value (NPV) of an investment equals zero.


Inventory:

Material that will eventually be fabricated and/or sold. Examples include the merchandise in a shop, finished goods in a warehouse, work in progress, and raw materials.


Inventory days:

A measure of how long it takes a company to sell the average amount of inventory on hand during a given period of time. To calculate inventory days, divide average inventory by cost of goods sold per day.


Invoice:

A bill submitted to a purchaser for goods or services rendered.


Leverage ratios:

Ratios related to a company's use of debt. They include interest coverage and debt to equity, and help people assess a company's ability to pay what it owes.


Liabilities:

The financial claims against a company's resources, including accounts payable, loans, and mortgages.


Net income:

An organization's profit after all expenses, including interest and taxes, are subtracted from revenue.


Net present value (NPV):

The estimated current value of an investment, calculated by subtracting the cost of the investment from the present value of the investment's future earnings.


Net profit margin:

A measure of a company's overall efficiency in generating profits. Also known as net profit margin.


Operating cash flow (OCF):

The net movement of cash from the operations side of a business, as opposed to cash related to investments or to a company's financing.


Operating expenses:

Expenses that are not directly attributed to manufacturing a product or delivering a service- for example, administrative salaries, rents, and sales and marketing costs.


Operating profit:

The sum remaining after all operating costs are subtracted from revenue. Also known as earnings before interest and taxes (EBIT).


Owners' equity:

The vale of a company's assets minus its liabilities. On a balance sheet, equity is referred to as shareholders' equity or owners' equity.


Payback period:

The length of time needed to recoup the cost of a capital investment.


Pretax profit:

Net income before income taxes.


Price-to-book ratio:

A ratio comparing the market's valuation of a company to the value of that company as indicated by its owners' equity.


Price-to-earnings ratio (P/E):

The current price of a share of stock divided by the previous 12 months' earnings per share. This ratio helps you compare stocks' value.


Productivity measures:

Indicators- Such as sales per employee and net income per employee- that link revenue and profit information to workforce data.


Profitability ratio:

Measures of a company's level of profitability, in which profits are expressed as a percentage of various other items. Examples include return on assets, return on equity, and return on sales.


Property, plant, and equipment (PPE):

A line on the balance sheet indicating how much money (after depreciation) a company has invested in fixed assets such as buildings and machinery.


Quick ratio:

A measure of a company's ability to meet its short-term obligations, also known as the acid test. To calculate the quick ratio, divide cash, receivables, and marketable securities by current liabilities.


Ratio Analysis:

A means of analyzing the information contained in the three financial statements. A financial ratio is two key numbers from a company's financial statements expressed in relation to each other.


Retained earnings:

All after-tax income held by a business (and not paid out in dividends) since its inception.


Return on assets (ROA):

A measure of the productivity of a company's assets. To calculate ROA, divide net income by total assets.


Return on equity (ROE):

A measure of the productivity of a company's equity. Also known as return on owners' equity. To calculate ROE, divide net income by owners' equity.


Return on sales (ROS):

A measure of a company's overall efficiency in generating profits. Also known as net profit margin. To calculate ROS, divide net income by total sales.


Revenue:

The first line on an income statement, indicating the value of goods or services delivered to Customers during the period of time covered by the statement. Also called sales.


Sales:

An exchange of goods and services for money. The first line on an income statement, indicating the value of goods or services delivered to Customers during the period of time covered by the statement. Also called sales.


Shareholders' equity:

The vale of a company's assets minus its liabilities. On a balance sheet, equity is referred to as shareholders' equity or owners' equity.


SWOT analysis:

An analysis of a company's strengths, weaknesses, opportunities, and threats.


Time value of money:

The principle that a dollar received today is worth more than a dollar expected at some point in the future.


Top-down budgeting:

A process whereby senior management sets specific objectives for items such as net income, profit margin, and expenses. Unit managers then put together their budgets within these parameters.


Valuation:

An estimate of a company's value for the purposes of purchase, sale, or investment.


Variable costs:

Costs that vary according to sales volume, such as the cost of materials and sales commissions.


Working capital:

A measure of a company's day-to-day liquidity. Working capital equals the difference between a company's current assets and its current liabilities.

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