Accounting and Finance Terms Referenced from the following Sources:

-A-

accounting model of business: similar to the Cash Flow Cycle (Higins,2009:p3) Cash flow within a business is tracked. Also called operating cycle where cash out goes to hire workers, procure materials, fund production and the generation of inventory while "cash in" is derived from sales and accounts receivable.

accounting rate of return method of corporate valuation: 

accrual accounting: see matching principle.

accrued expense:  an expense that is recognized on the Income Statement, when the associated cash outflow won't occur until some time in the future.

accounts payable (A/P):  Money that is owed to another

accounts receivable (A/R):  Money that is owed to us

acid test: current assets less inventory : current liabilities (similar to current ratio)

activity based costing: Overheads broken up into categories. Costs are associated with QC, purchasing, set-up and all aspects of creating, marketing and distributing a product. Identify cost attributes important to the customer. Similar to the lean concept that value is defined by the customer.

adjusted book value: book value +/- property revaluation +/- inventory revaluation +/- increase in inventory.

adjusting entries:  adjusting entries are made at the end of every reporting period (e.g., the end of every quarter). Usually one part of the entry adjusts the value of an asset or liability, while the other half of the entry affects the Income Statement.

amortize:  to assign a cost or value to a period of time. For instance, the costs of intangible assets are "amortized" in a fashion that is very like depreciation.  Depreciation is a special case of amortization.

ARR: (project/investment valuation) average annual cash inflow divided by total cash outflow. Weakness: Insensitive to the timing of cash flows.

-B-

basis points (bps): 1 hundredth of 1%. 1% change equals 100 basis points. 0.01 of 0.01 = 0.0001 (one ten-thousandth)

Balance Sheet (B/S): Show a company's financial position at a point in time

balanced scorecard: method emphasizing balance between the following factors: financial outcomes, customer service, internal business processes, vision and strategy, learning and growth.

bonds: Type of debt in which the full face (par) value is due at one point in time. "Taking on" more debt increases a firms financial risk.

book value: Equity/Number of Issued Shares

-C-

Capital Asset Pricing Model: (CAPM) equals risk free rate + beta( expected market return - risk free rate) Beta is a correlation coefficient between the company's equity performance and the wider stock market, often represented by the SP500. Beta greater than 1 means that a company is riskier than the average security.

Capital Redemption Reserve: A non-distributable reserve into which amounts are transferred following the redemption or purchase of a company's own shares (see section 733, UK Companies Act 2006).

Capitalization: when an expense is classified as an asset. Example: R&D expenses capitalized. Interest cost also capitalized.

Capital Rationing: Fixed budget which may not be exceeded.

Capital Usage Order: In order of decreasing risk: Retained Earnings, Debt, Equity (Common), Equity (Preferred)

cash flow: "Businesses that run out of cash fail."

cash flow statement: shows net movement of cash including operating activities, ROI, servicing of finance, taxation paid, Capex and financial investment, acquisitions and disposals, dividends paid, financing.

compound annual growth rate (CAGR): shows levelized growth per year according to the following formula: (Ending Value / Initial Value) ^ ( (1/number of years) -1)

contingent shares: shares issued based on a contingency. For example, if a company makes its profit targets, additional shares contingent on this target may be issued. Contingent shares increase the number of outstanding shares and dilute EPS.

contra-account:  an account that serves to reduce the value of another account. On the Balance Sheet, a contra-asset account has a credit balance and a contra-liability (or contra-owners' equity) account has a debit balance. A contra account is always associated with another specific account. Accumulated Depreciation and Accumulated Amortization are examples of contra-asset accounts, as is the Allowance for Uncollectible Accounts that reduces the value of Accounts Receivable.

Cost Gearing Ratio: Fixed Costs / Variable Costs. A low ratio of fixed to variable costs indicates a low risk, low return strategy. The break even point is easier to attain but profit per unit is lower. A company may signifigantly change its cost gearing and therefore its risk/return profile as the result of management policies such as cost reduction programs or acquisition related restructuring.

Cost of Capital Kw (see also WACC): cost of individual sources of capital, namely debt and equity, weighted by their contributions to a firm’s "capital structure". Kw = (% equity *  % required return on equity) + [ (1- tax rate) * ( % debt * % required return on debt) ].

-> Assumes that debt is tax deductible.

Cost of Debt (required rate of return on debt): Kd = rd*(1-Tc). This is the after tax cost of debt. One important benefit to debt is this "tax shield" effect. The cost of debt is an interest rate which is the required return on debt. Plug into the WACC formula.

Cost of Equity: (required rate of return on equity) Ke Typically greater than Kd. Determined through two models:

COS: Cost of Sales. For a manufacturing company, this includes manufacturing costs. For a retailing company, this includes purchasing costs. The COS can be thought of as a short term capital investment used for labor, materials, energy etc. Other operating expenses are not included.

Cost Structure: Where a businesses incurs costs. For example, software companies may have a high R&D expenditure, low fixed assets, but high labor costs. Comparisons could be made between software companies with similar cost structures.

creative accounting: producing statements that breach the intent of the law without necessarily breaking the law. Often, particular codes are used to achieve the accountants desired result. This is a legislative grey area. Asset based creative accounting can be: timing based, valuation based, recognition based or any combination of these.

creditors: payables

creditors (payables) turnover: (ratio analysis) payables*365/(COS +other operating expenses)

credit cycle: (ratio analysis) sum of inventory, debt and credit turnover. Expressed in days.

current ratio: current assets : current liabilities (see Review of Accounting) This ratio can easily be misinterpreted because it is based on the idea of converting current assets into cash, the primary activity of "old economy" companies. (Brown, 2012) This ratio fails to capture the retail (such as supermarket) businesses

-D-

debt: One type of funding by borrowed capital. Usually cheaper than equity.

debtors: receivables

debtors (receivables) turnover: (ratio analysis) receivables*365/Sales

depreciation expense:  The account on the income statement where the expense for depreciation on an asset is recorded.  Depreciation serves as a "reminder" of the cost that was incurred (at some point in the past) to support the operations of the company in the current period.

diluted share count: weighted average + contingent shares

dividend: non-tax deductible portion of profits paid to investors. A crucial and desirable "income stream" for investors.

dividend payout ratio: dividends/earnings. A measurement of the amount of dividends issued.

dividend rate: divident/shareholder's funds

dividend yield: dividend per share/share price

-E-

Earnings Yield: (Ratio Analysis) Earnings/Share Price

EBITDA: Earnings (Profit) before Interest, Taxes, Depreciation and Amortization.

EPS: Earnings per share. Profit/shares. EBIT used in place of profit by some analysts.

Equity: (multiple definitions) (1) Common stock. (2) On a company's balance sheet: Share Capital + Retained Earnings. When retained earnings are negative, shareholder's equity is reduced.

ESTA: Equity Stake in Traditional Assets. Defined in Hatherly 4 Fund model.

Expansion Costs (Business): Cost of investment to increase FA + Cost of investment to increase WC.

-F-

FA: Fixed Assets

Financial Analysis: Determining a company's true profitability, solvency/liquidity, fixed asset utilization, Working Capital utilization, and funding effectiveness.

financial leverage: the amount of equity used to finance assets

free cash flow (FCF): cash flow that remains after all obligations are paid. FCF represents the cash flow that management have genuine decision making authority over. How firms use this cash flow determines their effectiveness. FCF can be used in investments, to pay off debt or returned to shareholders as a dividend.

Future Value: (FV) Equals present value times (1 + i) ^n where n is the number of compounding periods.

funding cost: interest costs. Cost of capital, often expressed as the weighted average cost of capital or WACC.

 

-G-

Gearing: Using debt to fund a business. Two indicators of financial gearing are used: Capital Gearing which shows the B/S funding structure and Income Gearing which indicates a business's ability to support debt (loans).

"Grossed Up"- After Tax amount. Refers to the practice of increasing a payment so that the nominal value will be after relevant taxes.

Gross Profit: Sales - COS

Gross Profit Margin: Gross Profit / Sales. Companies with different cost structures must not be compared using gross profit margin.

 

-H-

hedge: strategy to offset risk

hurdle rate: minimum acceptable rate of return. See also cost of capital & acceptance criterion.

-I-

International Bank Account Number (IBAN):  Identifies an individual account, at a specific financial institution, in a particular country and is used to process financial transactions between institutions in different countries. Refer to the IBAN registry* for a list of countries that require IBANs and each country’s unique IBAN format. SWIFT (Society for Worldwide Interbank Financial Telecommunication) is the official IBAN registrar. (Source: https://www.wellsfargo.com/com/international/resources/iban)

impairment: to bring down assets to their actual value

income statement:  A financial statement that summarizes the revenues, costs and expenses of a company during an accounting period.

 

interest expense: The cost of using borrowed money.  It is accrued for the period and reported on the Income Statement. It's classified as a part of financing costs, which are reported separately from operating costs. However, on the Statement of Cash Flows, interest payments are reported as part of operating activity. This apparent contradiction is the sort accountants deal with routinely. If you read the deliberations of the rule-making body, you can find the arguments that were used in favor of alternative treatments and see the (often compromise) solutions that were reached.

inventory turnover: (Ratio Analysis) inventory*365/COS. Confusingly, also called stock turnover.

Investment Opportunity schedule (IOS):

investment in associates: ownership in other companies (called associates)

IRR: rate of return at which NPV equals zero.

-J-

-K-

“kill fees” (M&A ): defensive technique used to prevent a hostile takeover. Typically 3-4% of deal value, they add additional burden to the acquiring firm.

-L-

Laddering: technique used in financial analysis which isolates the use of company funds.

Lease: An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. (DH, IAS 17) Two categories: Operating Lease and Capital Lease.

-M-

marginal cost of capital: cost of raising one additional unit of currency. This increases as more capital is raised.

market to book: Market Cap. / Net Assets

matching principle:  revenue and expense recognition

minority interest: signifigant but non-controlling share of less than 50% of another companies stock.

MRQ:  Most Recent Quarter.

-N-

net income: Profit made by a company determined by subtracting all expenses from all revenues.

Net Present Value (NPV): FV-PV. Future value determined by discounting cash flows to present value. Always use WACC when calculating this.

 

net profit percentage: profit before tax / revenue * 100% (to get percentage)

nominal interest rate:  i=r+π;  the opportunity cost of holding money increases with the nominal interest rate, because the rate of return of bonds increases based on this.

-O-

OCF: operating cash flow. (ratio analysis) OCF/Sales ratio allows classification of a business as a "cash cow" or a "dog" for example. OCF/Fixed Asset Investment shows if a business can finance its assets from operating cash flow. Loans/OCF shows an indicator of the level of indebtedness of a firm. Can it quickly pay off its creditors?

Off Balance Sheet Finance: "creative accounting" process motivated by a firm's need to stay within borrowing limits, avoid breeching loan covenants, to improve credit rating or to appear better to investors. Examples: consignment stock; leasing (sale and lease-back); debt factoring; private finance initiative

OOE: Other operating expenses.

operating leverage: Fixed Costs / Variable costs

overtrading: when growth exceeds long term funding typically characterized by over-investment in current assets (receivables, inventory)

-P-

Payback Period: initial investment / annual return. Weakness: not appropriate for long time periods. See also discounted payback.

perpetuity: C/r where C is cash flow and r the discount rate. Present Value of an Infinite stream of equal value cash flows into the future.

PE multiplier: Share Price / EPS. Often used in company valuation.

Preferred Stock: Type of equity funding source which behaves in a manner between debt and equity. "Prefs" carry priority over assets or earnings and are marketed more narrowly than common stock.

Present Value: (PV) Equals to future value divided by (1 + i ) ^ n, where n equals the number of compounding periods.

proprietor's interest:  Owner's Interest; Shareholder's Interest

provision: temporary liability to account for future needs such as reorganization expenses. Not common due to accounting rule changes, it comes up most often with corporate reorganization. (Provision for re-organization following acquisition of subsidiary.) Must meet three criteria: Future Obligation, probably outflow of resource, reliable measure of future outflow.

-Q-

Quick Ratio: Also Known as: Acid Test: current assets less inventory : current liabilities (similar to current ratio)

-R-

ROA: return on assets. Net Earnings / Total Assets (Dupont Model)

ROE: Return on Equity. Profit after tax and minority interests / equity. ROE can be obtained by multiplying Net Profit Margin * Asset Turnover * Financial Leverage. As a financial health indicator, according to Higgins (p55 Analysis for Financial Management Intl. 9th Edition 2009) ROE has three problems: The Timing, Value and Risk Problems. The timing problem refers to the fact that ROE is “backward looking” based only on the last 12 months, making it short-sighted. ROE doesn’t account for the risk required to generate the return.

ROI: return on investment

Run Rate:  extrapolating a company's results out based on current revenue/earnings figures. Doesn't consider risks to future earnings/revenue, seasonality, or other reasons a company many not earn at the same rate in the future.

 

-S-

shareholder's funds: shareholder's equity

statement of cash flows: Change in Cash = Net Cash from (Ops) + (Investing) + (Financing )

sustainable grown rate g*: maximum rate sales can increase without depleting financial resources (overtrading). Answers the question: What is the level of retained earnings that will underpin sustainable company growth? Equal to the product of P R A T where P is profit margin (net), R is retention rate (plowback ratio), A is Asset Turnover and T is financial leverage.

sundry expenses: miscellaneous or infrequent expenses.

super-profits: Corporate income based valuation technique.

-T-

target costing: derive costs from the market (market research). The profit margin is deducted in order to back-calculate the cost.

term-sheet: (Venture Capital) Legal document outlining the terms under which an individual or firm will provide you money. Very important to read this skeptically and carefully.

three-fold demand for cash: working capital, opportunity capital, precautionary capital. (source: DH)

TIE: Times Interest Earned. Equals EBIT / Interest

timing based creative accounting:   (Examples) Reducing depreciation rates extends the depreciable life of an asset and increases profits by moving expense from earlier periods later. Changing sales cut-off (recognition) policy to shirt profits from a later period to an earlier one.

traditional costing: considers factors such as direct material costs, labor costs, production/non production overhead costs.

TTM: Twelve Training Months.

 

-U-

-V-

valuation methods: historic cost; depreciated historic cost; current cost; realisable value; replacement value; mark to market (or mark to model); fair value (current favorite)

value added: Non-Profit based performance measure. Value generated = Sales - purchased goods & services - depreciation. This value is distributed to as salary and pensions to employees, interest to loan holders, taxes to the government, dividends to shareholders and retained earnings for all groups. (Conservation of Value principle:) Value generated equals Value distributed. Used frequently in turn-around and takeover situations

-W-

Weighted Average Cost of Capital (WACC): Average of the required returns from the three long-term financing sources: the "cost of common equity", the "cost of preferred equity" and the "cost of debt". Using an after tax Kd results in an after-tax WACC discount rate which can be used in NPV calculations. When calculating the WACC, B/S liabilities must be "marked to market value". Bank loans can be taken at nominal value, but bonds and equity must be marked to market value.

working capital: (WC) = CA-CL. Sum of debtors, creditors and inventory.

working capital requirement: (WCR) Sum of inventory plus receivables minus payables. Also useful to express as a percentage of sales.

-Z-

Zero based budgeting (ZBB) - Budgeting method in which each year's budget process begins with with a blank sheet of paper, without referring to the previous year's cost structure. Beginning from scratch to determine budget allocations each year.