A

Accounts Payable (A/P)

Accounts Payable is the money you owe to your suppliers and vendors. It is part of Current Liabilities.

Also called Payables. Often called Creditors outside North America.

 

Accounts Payable (A/P)

Accounts Receivable (A/R)

Accounts Receivable is money your customers owe to you. It is part of Current Assets.

Also called Receivables. Often called Debtors outside North America. 

 

Accounts Receivable (A/R)

Accrual Basis

Accrual Basis is event-based accounting which recognizes Revenues and Expenses when they happen, not at the time they are paid.

See also Cash Basis.

 

Acid-Test Ratio

Acid-Test Ratio calculation: Quick Assets divided by Current Liabilities

where Quick Assets = Cash + Receivables + Short-Term Investments

Example: The Round Number Company

Cash = 10; Receivables = 20; Short-Term Investments = 3; Current Liabilities = 18

     Quick Assets =  10 + 20 + 3 = 33

     Acid-Test Ratio =  33/18 = 1.8

The Acid-Test Ratio is a variant of the Current Ratio; it only includes items which are quickly (and easily) converted into cash. It is called ‘Acid-Test’ because it measures the ability to meet unexpected demands without depending on the sale of inventory.

A ratio of 1 is a good benchmark. Higher ratios indicate a satisfactory condition. Decreasing ratios indicate either a deteriorating cash position or a deteriorating demand for products.

“What do you mean by that?”

Another definition of Quick Assets is: Current Assets less Inventories.  This definition includes Prepaid Expenses but they are not always quickly converted to Cash.

 

Acid-Test Ratio

Addition To Retained Earnings

At the end of the reporting period, the company can distribute some of the profit to the Shareholders as a Dividend. The remaining profit is added to Retained Earnings to fund growth; this is the Addition To Retained Earnings.

 

 

Addition To Retained Earnings

Adjustments

Adjustments are Revenues and Expenses that are not part of the regular business operation. Look at the Notes to the Financial Statement for a full explanation (Notes are part of the Financial Report).

In the Visual Finance graphics, adjustments indicating increased revenues to the business are represented by gold stacks.  Adjustments indicating increased expenses are represented by silver stacks. 

 

 

Adjustments

Administrative Overheads

Administrative Overheads are costs related to the corporate or administrative function rather than the production of goods and services. They include expenses such as salaries, rent and utilities, and other general office costs. These costs are reported in Selling, General & Administrative (SG&A).

 

Administrative Overheads

Amortization

Amortization is the process of decreasing an amount gradually (or in installments) to:

  1. Write down an expenditure. 
  2. Pay off a loan.
  3. Reduce the value of an Intangible Assets in a manner analogous to Depreciation.  NOTE: Intangible Assets do not ‘wear out’ so they do not depreciate.  Instead, Amortization is to spread the cost of the asset over the expected useful life, it is reported on the  Income Statement similar to Depreciation. (Impairment is a method of further reducing the value of an Intangible Asset.)

 

 

Asset Stripping

Asset Stripping has at least two definitions:

  1. (Owner’s view) Buying a company when its market value is below Book Value, then selling off its component assets to make a profit.
  2. (Manager’s view) Selling off non-essential or under-utilized Assets of a business in order to improve short-term metrics such as Return On Assets (ROA).

 

Asset Turnover (ATO)

Asset Turnover measures the efficiency with which a company uses its Assets to generate Sales.

     Ratio: Sales divided by Assets

Example: The Round Number Company

Sales = 100; Total Assets = 150

 Asset Turnover = 100/150 = 0.67

Asset Turnover shows the speed with which an amount of cash, equivalent to the money tied up in the business, comes back in through the door in fresh sales. It isn’t concerned with profit, only with cash flow. If sales are rapid, little cash is tied up to keep the business going; and if little cash is tied up in the business, it is easier to expand and make improvements.

See also Income|Outcome Triangle for Ratio Analysis.

Also called Asset Turns.

See also Net Asset Turnover.

 

Asset Turnover (ATO)

Asset Turns

Asset Turns measures the efficiency with which a company uses its Assets to generate Sales.

     Asset Turns ratio: Sales divided by Assets

Example: The Round Number Company

Sales = 100; Total Assets = 150

 Asset Turnover = 100/150 = 0.67

Asset Turns shows the speed with which an amount of cash, equivalent to the money tied up in the business, comes back in through the door in fresh sales. It isn’t concerned with profit, only with cash flow. If sales are rapid, little cash is tied up to keep the business going; and if little cash is tied up in the business, it is easier to expand and make improvements.

See also Income|Outcome Triangle for Ratio Analysis.

Also called Asset Turnover.

See also Net Asset Turnover.

 

Assets

Assets include anything that is owned and controlled by the business.

Current Assets include Cash, and things that can be expected to easily convert to cash: Receivables, Inventory, Prepaid Expenses and Short-Term Investments.

Fixed Assets include Property, Plant & Equipment, Intellectual Property, Goodwill, Long-Term Investments and other assets that have a more ‘permanent’ nature; they are intended to be held for the long term, not ‘turned over’ in the normal business cycle.

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

See also Current Assets and Fixed Assets.

 

Assets

Average Collection Period

The Average Collection Period ratio shows how quickly the proceeds from Sales are converted into Cash. It is the average number of days to receive payment.  

     Ratio: Receivables divided by Average Daily Sales 

     where Average Daily Sales = (Annual Sales/365).   

Example: The Round Number Company

Sales = 100; Receivables = 20

     Average Daily Sales = 100/365 = 0.274

     Average Collection Period = 20/0.274 = 73 Days

Average Collection Period is part of the Cash Conversion Cycle.   

Also called Days Sales Outstanding (DSO) or Days Sales in Receivables (DSR) or Days Receivables.

 

Average Collection Period

B

Balance Sheet

An organization reports its financial performance and position through the Balance Sheet, Income Statement, and Statement of Cash Flows

The Balance Sheet is a summary of the Assets, Liabilities, and Equity for the business at a certain point in time - it gives a financial snapshot for the given moment.

In the annual report the Balance Sheet  shows the state of the business at the end of the business year; it does not show how the business has changed over the year. Compare Balance Sheets for the current and previous periods to see the changes.

“What do you mean by that?”

The Balance Sheet can be one of two formats: Total Asset or Net Asset.

     Total Asset Balance Sheet (upper illustration)

North America uses a Total Asset Balance Sheet which shows the Assets (what you have in the business) and balances against where the funding for those Assets comes from:

Total Asset Balance Sheet Equation: 

Total Assets = Total Liabilities + Equity

Net Asset Balance Sheet  (lower illustration)

Elsewhere in the world, a Net Asset Balance Sheet may be used. It balances the ‘Net Assets’ (Total Assets less Liabilities) against the Equity.  The Net Asset Balance Sheet has advantages for measuring management performance, and is prevalent outside North America.

Net Asset Balance Sheet Equation:

Total Assets - Total Liabilities = Equity

“What do you mean by that?”

Any term which uses the phrase ‘net asset’ or ‘net assets’ must be examined closely.  See discussion at Net Asset.

 

Balance Sheet Balance Sheet

Book Value of Assets

Book Value of Assets is the value of Current Assets and Fixed Assets as they are listed on the Balance Sheet. (The Market Value is the amount the assets could be sold for.)

Calculation: Purchase value of Assets less accumulated Depreciation.

 

 

Book Value of Assets

Book Value of Business

We say Book Value is the 'Net Asset Value of a company' but there are various definitions of Net Assets

“What do you mean by that?”

1. Book Value is the Net Asset Value of a company. It is a very conservative ‘worst-case’ valuation of what a business would be worth if it had to close down.

Book Value calculation: Total Assets less Intangible Assets less Goodwill less Liabilities.

Book Value per Share ratio: Book Value divided by Number of Shares issued.

Example: The Round Number Company

Goodwill is also an Intangible so it is included in the calculation.

Total Assets = 150; Intangibles = 10; Goodwill = 4; Liabilities = 80

     Book Value Of Business = 150 - 10 - 4 - 80 = 56

If the Round Number Company has issued 100 shares;

     Book Value per Share = 56/100 = 0.56

2. Another definition of ‘Book Value’ does not subtract the value of Intangible Assets (e.g. Goodwill and Intellectual Property). In this situation, Book Value is the same as Equity.

Book Value calculation: Total Assets less Liabilities.

Book Value per Share ratio: Book Value divided by Number of Shares issued.

Total Assets = 150; Liabilities = 80

     Book Value Of Business = 150 - 80 = 70

If the Round Number Company has issued 100 shares;

     Book Value per Share = 70/100 = 0.7

Be sure to know which definition is being used!

 

Book Value per Share

We say Book Value is the 'Net Asset Value of a company' but there are various definitions of Net Assets

“What do you mean by that?”

1. Book Value is the Net Asset Value of a company. It is a very conservative ‘worst-case’ valuation of what a business would be worth if it had to close down.

Book Value calculation: Total Assets less Intangible Assets less Goodwill less Liabilities.

Book Value per Share ratio: Book Value divided by Number of Shares issued.

Example: The Round Number Company

Goodwill is also an Intangible so it is included in the calculation.

Total Assets = 150; Intangibles = 10; Goodwill = 4; Liabilities = 80

     Book Value Of Business = 150 - 10 - 4 - 80 = 56

If the Round Number Company has issued 100 shares;

     Book Value per Share = 56/100 = 0.56

2. Another definition of ‘Book Value’ does not subtract the value of Intangible Assets (e.g. Goodwill and Intellectual Property). In this situation, Book Value is the same as Equity.

Book Value calculation: Total Assets less Liabilities.

Book Value per Share ratio: Book Value divided by Number of Shares issued.

Total Assets = 150; Liabilities = 80

     Book Value Of Business = 150 - 80 = 70

If the Round Number Company has issued 100 shares;

     Book Value per Share = 70/100 = 0.7

Be sure to know which definition is being used!

 

Break-Even Analysis AND Break-Even Point

Break-Even Analysis looks at the interrelationship of Sales (price and volume), Fixed Cost and Variable Costs. It is typically done as a graphical representation.

The Break-Even Point is the point at which Sales are equal to Total Costs (i.e. Fixed costs plus Variable Costs). It is the combination of sales and costs that yields a no-profit, no-loss situation.

Also known as Break-Even Sales.

 

Break-Even Analysis AND Break-Even Point

Budget

A Budget is the expectations of Sales, Costs & Expenses and Profit for a future fiscal period (month, quarter, year).

This is definitely a What do you mean by that? term. Many people use it to mean ‘the amount of money they are allowed to spend’, meaning only ‘their’ costs/expenses portion of the actual budget.

 

Budget

C

CapEx

Capital Expenditure or CapEx is money spent to acquire, improve, or maintain Fixed Assets.

Note: OpEx refers to Operating Expenses on the Income Statement. CapEx refers to a Capital Expenditure on the Balance Sheet.

 

Capital

Ask What do you mean by that

Capital is a broad term with multiple meanings - it generally means something that is of value to the owners (e.g. PP&E or Intellectual Property or Cash). It can also mean Equity

Note: Capital is not the same as Capital Stock.

 

Capital Expenditure

Capital Expenditure or CapEx: Money spent to acquire, improve, or maintain Fixed Assets.

Note: OpEx refers to Operating Expenses on the Income Statement. CapEx refers to a Capital Expenditure on the Balance Sheet.

 

Capital Stock

The original investment in the company, plus any additional investment from outside the company; Capital Stock does not include Retained Earnings.

Capital Stock is part of Shareholders’ Equity. Look at the Financial Statements to see how Equity is broken out into the different sources. 

Also known as Share Capital.

Note: Capital Stock is not the same as Capital.

 

 

Capital Stock

Cash

Cash on hand, in the bank, or otherwise very readily accessible.

Cash drives the business!

Also called Cash On Hand or Cash & Equivalents.

 

Cash

Cash Basis

An accounting method which tracks incomes and outlays by when the Cash comes in or goes out, not when events happen.

See also Accrual Basis.

 

Cash Conversion Cycle

Calculation: CCC = DIO + DSO - DPO

Example: The Round Number Company

The values are calculated for each term under their individual listings.

DIO = Days Inventory Outstanding = 227 Days

DSO = Days Sales Outstanding (DSO)= 73 Days

DPODays Payable Outstanding = 91 Days

     Cash Conversion Cycle = 227 + 73 - 91 = 209 Days

This metric takes into account how much time the company needs to sell its Inventory, how much time it takes to collect Receivables, and how much time it has to pay its bills (Payables). A lower number is preferred.

 

Cash Conversion Cycle

Cash Flow

The flow of money into and out of the business. Understanding the Cash Flow of a business is as essential as understanding Profit; the two have to be managed separately.

See Cash Flow Statement for a description of the Cash Flows in and out of the business.

See also Cash Flow Forecast (CFF)

Income|Outcome Learning

Profit is like food: you need it for the business to grow and to be healthy and strong; but you don’t have to eat all the time. But Cash is like air – you need it constantly.  If you run out, and cannot immediately get more, you die. 

Profit happens on the Income Statement. Cash Flow happens on the Balance Sheet.

 

 

Cash Flow

Cash Flow Forecast (CFF)

The Cash Flow Forecast is a projection of the cash flows, in and out, over a fiscal period of projection, to determine net cash balances at particular points in time. This identifies either the need for additional cash infusions or the opportunity to use excess cash elsewhere.

It is a tool for analyzing the timing and severity of your cash flow problems and allows you to address the following:

After you have completed your strategic plan, you will want to know if it can actually work - whether you have the cash flow to support it. If you do not have the cash, you may go bankrupt, even if you have a profitable business!

Cash Flow Forecasts can also improve your ability to borrow. They give you advance warning of a cash crisis, so you know the best time to take out a loan.

 

Cash Flow Statement

An analysis of sources of cash that flowed into and out of the business for the accounting period. The information is grouped by functional departments, because Cash can be freed up from anywhere (such as getting customers to pay faster, or paying suppliers more slowly), not just from Sales or the Finance Department.

Cash Flow Statement Equation: CF from Operations + CF from Investing + CF from Financing = Net Change in Cash

The Cash Flow Statement starts by looking at changes in Cash due to Operations;

      Net Income for the current period

     + Non-Cash Deductions (e.g. Depreciation and Amortization)

     = Cash Flow

add changes in Net Working Capital;

     - increases in Receivables and Inventories;  + increases in Payables

     = Operating Cash Flow

add changes in Investing;

     + proceeds from sale of Fixed Assets;  - expenditure for new Fixed Assets

     + revenues from investment securities   

     + proceeds from sales of securities;  - expenditure on new securities

    = Free Cash Flow

add changes in Financing;

     new Loans; - repaid loans

     Cash from investors; - dividends or stock repurchase

      = Change in Cash position

The final result is the Change in Cash  (i.e. from the end of the previous period).

Cash at end of Period = Cash at end of Previous Period + Change in Cash Position

 

Also known as the Statement of Cash Flows.

 

Cash Ratio

Ratio: Cash divided by Current Liabilities

Example: The Round Number Company

Cash= 10; Current Liabilities = 18

     Cash Ratio  = 10/18 = 0.56

 This is another variant of the Current Ratio, it is more conservative than the Acid-Test Ratio.

 

Cash Ratio

Contribution and Contribution Margin

Calculation: Sales less the Cost of Sales.

Ratio: Contribution as a percentage of Total Sales 

Example: The Round Number Company

Sales = 100, COGS = 40

     Contribution = 100 - 40 = 60

     Contribution Margin = 60/100 = 60%

 

Sales or sales

“What do you mean by that?”

For the Round Number Company, Sales = 100 so Contribution and Contribution Margin look to be the same number.  If Sales and Cost of Sales both double, the Contribution changes, but the Contribution Margin remains the same:

     Contribution = 200 - 80 = 120

     Contribution Margin = 120/200 = 60%

“What do you mean by that?”

Some people use Contribution to be the same term as Gross Profit; others may use the term earlier (e.g. higher up) on the Income Statement.

“What do you mean by that?”

Contribution Margin is the ratio of Contribution to Sales, but some people use the two terms (Contribution and Contribution Margin) interchangeably.

 

Contribution and Contribution Margin Contribution and Contribution Margin

Cost of Capital

A weighted average of the interest cost of debt and the expectations of the shareholders. 

Example:

If half the company’s capital comes from borrowing at 8%, and half from investors who expect 15% return on investment, the Cost of Capital is deemed to be 11.5%.

 

 

Cost of Goods Sold (COGS)

The Direct Cost of products and/or services provided to customers. COS typically includes raw materials and labor, it can also include individual components such as sales commission and depreciation. This reporting varies on a company-by-company basis.

Cost of Sales is a Variable Cost because the cost reported varies with sales volume.

The terms Cost of Sales, Direct Costs, and Variable Costs are very similar. Check how each term is used in your company.

In Manufacturing, Cost of Sales is often called Cost of Goods Sold or COGS.

 

Cost of Goods Sold (COGS) Cost of Goods Sold (COGS)

Cost of Sales (COS)

The Direct Cost of products and/or services provided to customers. COS typically includes raw materials and labor, it can also include individual components such as sales commission and depreciation. This reporting varies on a company-by-company basis.

Cost of Sales is a Variable Cost because the cost reported varies with sales volume.

The terms Cost of Sales, Direct Costs, and Variable Costs are very similar. Check how each term is used in your company.

In Manufacturing, Cost of Sales is often called Cost of Goods Sold or COGS.

 

Cost of Sales (COS)

Costs & Expenses

“What do you mean by that?”

The words 'costs' and ‘expenses' are sometimes used interchangeably. However, some companies use the word ‘cost’ to refer to items that are recorded above the Gross Profit line on the Income Statement and ‘expense' to refer to items that are recorded lower down.

     Costs & Expenses above Gross Profit:

     Costs & Expenses below Gross Profit and above Operating Income:

     Costs & Expenses below Operating Income (EBIT):

Note: Some companies record Depreciation as part of COS or COGS (i.e. part of the Direct Costs); other companies record it as a line item in Operating Expenses. For companies using EBITDA, it is recorded below the EBITDA line of the Income Statement.

“What do you mean by that?”

Ask if the terms ‘cost’ and ‘expense’ have specific meaning in your company.

 

Costs & Expenses

Creditors

Money you owe to your suppliers and vendors. Part of Current Liabilities.

In North America, typically called Accounts Payable (A/P) or Payables.

 

Creditors

Current Assets

The Assets of a company that are Cash or reasonably expected to be converted to cash, or consumed within 12 months from the date of the Balance Sheet.

Current Assets include Cash, Receivables, Inventory, Prepaid Expenses and Short-term Investments.

 

Current Assets

Current Debt

Current Debt is the portion of Current Liabilities that is related to borrowing money (i.e. interest-bearing bank loans). ‘Current’ indicates it is falling due within the fiscal year (or within the next 12 months).

 Current Debt includes short-term Loans and the Current Portion Of Long-Term Debt.

Also called Short-term Debt.

 

Current Debt

Current Liabilities

Liabilities that are due within 12 months of the date of the Balance Sheet.

Current Liabilities include Payables and Short-Term Debt.

Also known as Short-term Liabilties

See also Current Portion Of Long-Term Debt.

 

Current Liabilities

Current Portion Of Long-Term Debt

Long-term Debt is the portion of Long-Term Liabilities that is related to borrowing money (i.e. bank Loans) - it is interesting bearing, and it is initially taken for a period greater than 1 year. 

However, the Current Portion of Long-term Debt (i.e. that portion falling due within 12 months of the Balance Sheet date) is reclassified as Short-term Debt because repayment is an immediate concern.

 

Current Portion Of Long-Term Debt

Current Ratio

Ratio: Current Assets divided by Current Liabilities.

Example: The Round Number Company

Current Assets = 66; Current Liabilities = 18

     Current Ratio = 66/18 = 3.7

This ratio is a measure of the company’s liquidity. It looks at the ability to pay bills (Short-term Debt) out of the Current Assets

Also known as the Working Capital Ratio.

See also Liquidity Ratios, Acid-Test Ratio, Cash Ratio.

 

Current Ratio

D

Days Inventory Outstanding

Ratio: Inventory divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company

COS = 40; Inventory = 25

     Average Daily COS = 40/365 = 0.11

     Days Inventory Outstanding = 25/0.11 = 227 Days

The ratio shows how quickly inventories are converted into Cash.

Days Inventory Outstanding is part of the Cash Conversion Cycle.

Also called Days Sale Inventory or Days On Hand (DOH).

 

Days Inventory Outstanding

Days Payable Outstanding

Ratio: Payables divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company

COS = 40; Payables = 10

     Average Daily COS = 40/365 = 0.11

     Days Payable Outstanding = 10/0.11 = 91 Days

The ratio shows the company’s average payable period.

Days Payable Outstanding is part of the Cash Conversion Cycle.

 

Days Payable Outstanding

Days Sale Inventory

Ratio: Inventory divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company

COS = 40; Inventory = 25

     Average Daily COS = 40/365 = 0.11

     Days Sales Inventory = 25/0.11 = 227 Days

The ratio shows how quickly inventories are converted into Cash.

Days Sales Inventory or Days Inventory Outstanding is part of the Cash Conversion Cycle.

Also called Days Inventory Outstanding or Days On Hand (DOH).

 

Days Sale Inventory

Days Sales In Receivables

Ratio: Receivables divided by the Average Daily Sales

where Average Daily Sales = (Annual Sales/365).

Example: The Round Number Company

Sales = 100; Receivables = 20

     Average Daily Sales = 100/365 = 0.274

     Days Sales Outstanding = 20/.274 = 73 Days

The ratio shows how quickly the proceeds from sales are converted into Cash.

Days Sales Outstanding is part of the Cash Conversion Cycle.

Also known as Days Sales Outstanding or Average Collection Period.

 

Days Sales In Receivables

Days Sales Outstanding (DSO)

Ratio: Receivables divided by the Average Daily Sales

where Average Daily Sales = (Annual Sales/365).

Example: The Round Number Company

Sales = 100; Receivables = 20

     Average Daily Sales = 100/365 = 0.274

     Days Sales Outstanding = 20/.274 = 73 Days

The ratio shows how quickly the proceeds from sales are converted into Cash.

Days Sales Outstanding is part of the Cash Conversion Cycle.

Also known as Average Collection Period or Days Sales In Receivables

 

Days Sales Outstanding (DSO)

Debt

“What do you mean by that?”

‘Debt’ can have wildly different meanings, here are some possibilities:

  1. In published Financial Statements, Debt refers to Interest-bearing liabilities such as Loans. It does not include non-interest bearing liabilities such as Payables and Pensions.
  2. In the Debt-to-Equity ratio, Debt refers to the total Liabilities listed on the Balance Sheet . It includes both interest-bearing and non-interest bearing liabilities.
  3. Another meaning is only the Long-term Liabilities listed on the Balance Sheet.

Make sure you agree on the meaning!

See the discussion at Leverage.

 

Debt to Equity Ratio

Ratio: Liabilities divided by Equity.

Example: The Round Number Company

Total Liabilities = 80; Equity = 70

     Debt-to-Equity = 80/70 = 1.14

“What do you mean by that?”

This ratio is a measure of the company’s safety, or ability to withstand adversity. This is a real What do you mean by that? term. What is meant by ‘debt'? Total Liabilities? Interest-bearing debt? Long-term debt? See the discussion at Debt.

 

Debt to Equity Ratio

Debtors

Money your customers owe to you.  Part of Current Assets.

In North America, Debtors is typically called Receivables or Accounts Receivable (A/R).

 

 

Debtors

Depreciation

Depreciation is a non-cash expense (reported on the Income Statement) that expresses the reduction in economic value of a Tangible Asset over time.  Depreciation reflects the wear and tear of an asset over time. 

Some companies record Depreciation as part of COS/COGS (i.e. it is part of the Direct Cost); other companies record it as a line item in Operating Expenses.

For companies using EBITDA, Depreciation is recorded below the EBITDA line of the Income Statement.

NOTE: Intangible Assets do not ‘wear out’ so they do not Depreciate.  Instead, Amortization is to spread the cost of the asset over the expected useful life, it is reported on the  Income Statement similar to Depreciation. (Impairment is a method of further reducing the value of an Intangible Asset.)

 

Depreciation

Direct Cost

Direct Costs are costs that can be easily and accurately traced to a specific product or service. Examples include raw materials and labor. But some companies will also include Depreciation, Factory or Site Overheads, and sales commissions.

The terms Cost of Sales, Direct Costs, and Variable Costs are very similar. Check how each term is used in your company.

See also Indirect Cost.

See more at the Income|Outcome Blog: WHAT ARE DIRECT COSTS VS INDIRECT COSTS?

 

Direct Cost

Discounted Cash Flow (DCF)

A calculation of the future value of expected inflows and outflows of cash. 

Future cash flows need to be appropriately discounted to allow for the fact that money that comes back in next year is worth less than money that goes out today.

 

 

Discounting Receivables

Selling a Receivable note (e.g. an invoiced sale) at a discount in order to receive immediate Cash.

Also called Factoring.

 

Discounting Receivables

Discounting Sales

Reduction in the sales price of goods and services, often to entice additional sales. This can be based on volume, seasonality, obsolescence, a changed competitive environment, or future commitments by the customer.

 

Dividend

At the end of the reporting period, the company can distribute some of the profit to the Shareholders as a Dividend. The remaining profit is added to Retained Earnings to fund growth.

Ratio: Net Income divided by Dividends

Example: The Round Number Company

The Round Number Company made a profit of 15, and the entire amount was added to Retained Earnings

If instead the owners declare a Dividend of 5, then the Net Income is still 15, but the Addition To Retained Earnings is only 10.  (Payment of the Dividend would reduce Cash by 5, so the Balance Sheet will still balance.)

     Dividend Cover = 15/5 = 3

If the Dividend Cover is greater than 1, it means the business has reinvested some profit back into itself – the higher the number the greater the re-investment. Generally, a dividend cover of 2 or more is considered a safe coverage - it allows the company to safely pay out dividends and still allow for reinvestment or the possibility of a downturn.

Some companies occasionally pay Dividends greater than their Earnings; this may happen if they take a temporary loss and want to send a signal that the loss does not matter. Failing to pay an expected dividend signals that the company has run into unexpected difficulty, and this may hurt the price of shares. It shrinks the size of the business to pay a dividend greater than earnings, but a high stock price is important if the company wants to raise more capital by issuing shares. The company wants the most money for the fewest new shares issued.

 

Dividend

Dividend Cover

Ratio: Net Income divided by Dividends

Example: The Round Number Company

The Round Number Company made a profit of 15, and the entire amount was added to Retained Earnings

If instead the owners declare a Dividend of 5, then the Net Income is still 15, but the Addition To Retained Earnings is only 10.  (Payment of the Dividend would reduce Cash by 5, so the Balance Sheet will still balance.)

     Dividend Cover = 15/5 = 3

If the Dividend Cover is greater than 1, it means the business has reinvested some profit back into itself – the higher the number the greater the re-investment. Generally, a dividend cover of 2 or more is considered a safe coverage - it allows the company to safely pay out dividends and still allow for reinvestment or the possibility of a downturn.

Some companies occasionally pay Dividends greater than their Earnings; this may happen if they take a temporary loss and want to send a signal that the loss does not matter. Failing to pay an expected dividend signals that the company has run into unexpected difficulty, and this may hurt the price of shares. It shrinks the size of the business to pay a dividend greater than earnings, but a high stock price is important if the company wants to raise more capital by issuing shares. The company wants the most money for the fewest new shares issued.

 

 

Dividend Cover

E

Earnings

Calculation: Sales less all Costs and expenses

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36; Finance = 4; Tax = 5

(In this example, the Adjustments cancel out)

     Net Income = 100 - 40 - 36 - 4 - 5 = 15

Earnings is the profit for the period after all costs and expenses have been paid.

“What do you mean by that?”

The term 'Earnings' is also used higher up the Income Statement: Earnings Before Interest and Tax, Earnings before Tax.

Outside North America, Earnings is more likely to be called Profit or Net Income or Net Profit.  See discussion at Operating Income

 

Earnings

Earnings Before Interest and Taxes (EBIT)

Calculation: Sales less all Costs and Expenses except Finance Charges and Inventory Turns (and Adjustments)

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36

     EBIT = 100 - 40 - 36  = 24

EBIT is the amount of Profit available after deducting from Sales the costs associated with the operations of the company (Cost of Sales, SG&A), but before paying finance charges and taxes.

“What do you mean by that?”

Outside North America, EBIT is more likely to be called Operating Profit or Operating IncomeSee discussion at Operating Income

 

 

Earnings Before Interest and Taxes (EBIT)

Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA)

Calculation: Sales less all cash expenses except Finance Charges and Income Tax (and Adjustments).

EBITDA is the amount of Profit available after deducting from Sales the cash expenses associated with the operations of the company (Cost of Sales, SG&A but not Deprecation), and before paying finance charges and taxes.

EBITDA is used to evaluate a company's operating performance without factoring in financing decisions, accounting practices, or tax environments.

EBITDA does not include the non-cash expenses such as Depreciation and Amortization.

 

Earnings Before Tax

Calculation: Sales less all expenses except Inventory Turns (and Adjustments). 

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36; Finance = 4

     EBT = 100 - 40 - 36 - 4 = 20

Earnings Before Tax is the amount of Profit available after deducting from Sales the costs associated with the operations of the company (Cost of Sales, SG&A) as well as finance charges, but before paying taxes.

 

Earnings Before Tax

Earnings Per Share (EPS)

Ratio: Net Income divided by the number of shares issued and outstanding. 

Example: The Round Number Company

Net Income = 15

If the Round Number Company has issued 100 shares,

     Earnings per Share = 15/100 = 0.15

 

EPS is the net benefit to the shareholder per share; it does not say whether the earnings are paid out as dividends or retained in the company for growth.

 

Equity

The ownership the shareholders have in the company, represented by the Capital Stock, Retained Earnings, Treasury Stock, and other. 

Look at the Financial Statements to see how Equity is broken out into the different sources.

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

Also called Shareholders’ Equity or Net Worth.

 

Equity

Expense

See the discussion of Costs and Expenses.

 

F

Factoring

Selling a Receivables at a discount in order to receive immediate Cash.

Also called Discounting Receivables.

 

Factoring

Factory Overheads OR Site Overheads

Factory Overheads are costs that are connected directly to the production of goods and services but they are not identified as labor or materials. Examples include Depreciation of equipment at a production site, rent for a retail site, utilities for locations other than corporate offices.

The reporting of these costs will vary by company - some or all of these costs can be:

Admin Overheads are not directly connected to the production of goods and services, they are reported in Selling, General & Administrative (SG&A)

Factory Overheads might be called Site Overheads in non-manufacturing industries. 

See also Direct Cost, Semi-variable Costs.

 

Finance Charges

Expenses associated with financing the business; includes Interest, Factoring expense, foreign exchange costs, currency hedging, etc.

 

Finance Charges

Financial Statements

Financial Statements show how a business is doing financially. They help stakeholders understand the performance and financial position of the business.

There are three main types of financial statements:

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

Income Statement Equation: Sales Revenue – Expenses = Profit

Cash Flow Statement Equation:

CF from Operations + CF from Investing + CF from Financing = Net Change in Cash

 

Note: See Cash Flow Statement for the actual analysis.

 

 

Finished Goods Inventory (FGI)

Fully produced goods which are available for sale to customers. Inventories are part of Current Assets.

 

Finished Goods Inventory (FGI)

Fixed Assets

Fixed Assets are Assets which are categorized as ‘permanent’ and not intended to be ‘turned over’ in the normal business cycle.

Fixed Assets may be tangible items such as land, buildings, equipment and furniture with a useful business life of greater than one year; or they may be intangible items such as Goodwill and Intellectual Property. Long-Term Investments are also Fixed Assets.

“What do you mean by that?”

Some companies use the grouping Non-Current Assets to include Tangible Assets and a second grouping grouping Intangible Assets for Intangible Assets (Goodwill and Intellectual Property).

 

Fixed Assets

Fixed Cost

The terms Fixed Costs and Variable Costs look at the behavior of the costs - do the costs vary with Sales Volume?

Note: Advertising is considered a Fixed Cost. An increase in Advertising might lead to higher sales or it might not. There is no direct relationship - doubling the Advertising spend will not double Sales Volume.

Note: The terms Overhead(s), Operating Expense (OpEx), Indirect Costs, and Fixed Costs are very similar. Check how each term is used in your company.

See also Variable Costs and Semi-Variable Costs.

 

Fixed Cost

G

Goodwill

An Intangible Assets that arises when a company is acquired and the purchase price is more than its Book Value.

The value of an Intangible Asset can be amortized over time, the Amortization is reported is reported alongside Depreciation on the Income Statement.

The amortized value must be re-evaluated on a periodic basis; if the recoverable value of the asset falls below the value listed on the Balance Sheet, an Impairment loss is recorded on the Income Statement.

 

 

Goodwill

Gross Margin

Gross Margin Ratio: Gross Profit as a percentage of Sales

where Gross Profit = Sales less Direct Cost 

Example: The Round Number Company

Sales = 100; Direct Costs (i.e. COGS) = 40

     Gross Profit = 100 - 40 = 60

     Gross Margin = 60/100 = 60%

Gross Margin, indicates the portion of Sales that remains after covering the Direct Costs.  (Gross Profit represents the amount of profit remaining after subtracting the Direct Costs of labor and materials from Sales. Some companies may also include relevant overhead costs associated with the production of goods and services in their Direct Costs.)

Note: In the above example, Gross Profit and Gross Margin have the same value but it is because we have been using round numbers based on Sales of 100 - this is not real-world.   

Example:  

Sales = 200, Direct Cost = 90

     Gross Income = 200 - 90 = 110.

     Gross Margin = 110/200 = 55%.

 “What do you mean by that?”

Some people use the terms Gross Profit and Gross Margin interchangeably.  The same thing can happen with Gross Margin and Margin (which can have other meanings).  Make sure you understand which term is being used!  

Gross Profit is also known as Gross Income.

See also the discussion at Contribution.

 

Gross Margin Gross Margin

Gross Profit

Gross Profit calculation: Sales less Direct Cost 

Gross Margin ratio: Gross Profit as a percentage of Sales 

Example: The Round Number Company

Sales = 100; Direct Costs (i.e. COGS) = 40

     Gross Profit = 100 - 40 = 60

     Gross Margin = 60/100 = 60%

Gross Profit represents the amount of profit remaining after subtracting the Direct Cost of labor and materials from Sales. Some companies may also include relevant overhead costs associated with the production of goods and services in their Direct Costs.

Gross Margin, indicates the portion of Sales that remains after covering the Direct Costs.

Note: In the above example, Gross Profit and Gross Margin have the same value but it is because we have been using round numbers based on Sales of 100 - this is not real-world.   

Example:  

Sales = 200, Direct Cost = 90

     Gross Income = 200 - 90 = 110.

     Gross Margin = 110/200 = 55%.

 “What do you mean by that?”

Some people use the terms Gross Profit and Gross Margin interchangeably.  The same thing can happen with Gross Margin and Margin (which can have other meanings).  Make sure you understand which term is being used!  

Gross Profit is also known as Gross Income.

See also the discussion at Contribution.

 

Gross Profit Gross Profit

Gross Sales

Total Sales revenue before applying any sales discounts, allowances or returns. 

See also Sales; Net Sales.

 

Gross Sales

I

Impairment

Impairment is a method of accounting for the loss in value of an Intangible Assets. If the value of an Intangible Asset listed on the Balance Sheet exceeds its ‘recoverable’ value, the asset is revalued on the Balance Sheet and an impairment loss is reported on the Income Statement.

Amortization is also used to reduce the  value of the Intangible Asset over its expected useful life; this is similar to the Depreciation of Tangible Assets. If the market value is less than the balance sheet value after amortization, then an Impairment occurs.  

“What do you mean by that?”

The ‘recoverable’ value is the higher amount between 1) the value you can get from selling the asset or 2) the value you can get from using the asset.

 

Income

Ask, "What do you mean by that?". It could mean Sales Income (Sales Revenue at the top of the Income Statement), or it could mean Net Income (Net Profit at the bottom of the Income Statement).

 

Income

Income Statement

A summary of the income and expenses for the company over the operating period – a financial History Book for the fiscal period. The Income Statement in the Annual Report shows the total income and expenses (and the profit or loss) for the business over the entire business year. 

Income Statement Equation: Sales Revenue – Expenses = Profit

→ The left side of the Visual Finance image is an Income Statement.

Also known as the ‘P&L’ or a Profit and Loss Statement.

 

Income Statement

Income Tax

Taxes paid to government authority based on profits made by the company. 

 

Income|Outcome Triangle for Ratio Analysis

A Visual Finance representation of the relationships between Sales, Net Income and Assets.

(The Income|Outcome simulation game board has a format similar to Visual Finance--complete representation of Income Statement and Balance Sheet laid out side-by-side. This allows the overlay of this triangle for Ratio Analysis of business results.)

 

Income|Outcome Triangle for Ratio Analysis

Indirect Costs

Indirect Costs are incurred in the general operations of the business, they are not tied directly to the production of goods and services. Examples include R&D, advertising, salaries for non-production personnel, training, and rent for corporate offices.

Indirect Costs are often considered ‘fixed’ because they are approximately the same from month to month - the rent for Administrative offices does not change if you double your sales from one month to the next.

The terms Direct Cost, OpEx, Indirect Costs, and Fixed Costs are very similar. Check how each term is used in your company.  

See also Direct Costs.

See more at the Income|Outcome Blog: WHAT ARE DIRECT COSTS VS INDIRECT COSTS? 

 

Indirect Costs

Intangible Assets

A Fixed Asset which has a perceived value but without a tangible nature. A typical example is Intellectual Property. Goodwill is also an Intangible Asset but it is often broken out as a separate line item on the Balance Sheet.

The value of an Intangible Asset can be amortized over time, the Amortization is reported is reported alongside Depreciation on the Income Statement.

The amortized value must be re-evaluated on a periodic basis; if the recoverable value of the asset falls below the value listed on the Balance Sheet, an Impairment loss is recorded on the Income Statement.

 

Intangible Assets

Intellectual Property (IP)

Copyrights, Patents, Trademarks and Service Marks.

Intellectual Property is a Intangible Asset.

 

Intellectual Property (IP)

Inventory

Raw materials, work in process (WIP), and finished goods.  All inventories are Current Assets

 

 

Inventory

Inventory Turnover

Ratio: Cost of Sales (COS) divided by the average value of Inventory on hand.  

Example: The Round Number Company

Cost of Sales = 40; Inventory = 25

     Inventory Turnover = 40/25 =1.6

This ratio is the number of times a business sells out its Inventory during the year.

Also called Inventory Turns.

 

 

Inventory Turnover

Inventory Turns

Ratio: Cost of Sales (COS) divided by the average value of Inventory on hand.  

Example: The Round Number Company

Cost of Sales = 40; Inventory = 25

     Inventory Turnover = 40/25 =1.6

This ratio is the number of times a business sells out its Inventory during the year.

Also called Inventory Turnover.

 

Inventory Turns

L

Leverage

Leverage is how much you extend your assets by borrowing against your investment. 

Leverage Ratios incorporate Liabilities and either Assets or Equity.

Example:  

If you invest $60K of your money in a business, and borrow an additional $30K from the bank, you have assets of $90K. You can express your leverage in several ways:

Debt to Equity : 30/60 = .5

Debt Ratio (i.e. Debt to Assets): 30/90 = .33

Both these numbers are expressing the same situation, and both can be called leverage. The first person might say, “We’re leveraged 50%”; the second person could say, “We’re leveraged 33%."

If someone mentions 'leverage' be sure to ask, “What do you mean by that?

 

Leverage

Leverage Ratios

Leverage is how much you extend your assets by borrowing against your investment. 

Leverage Ratios incorporate Liabilities and either Assets or Equity.

Example:  

If you invest $60K of your money in a business, and borrow an additional $30K from the bank, you have assets of $90K. You can express your leverage in several ways:

Debt to Equity : 30/60 = .5

Debt Ratio (i.e. Debt to Assets): 30/90 = .33

Both these numbers are expressing the same situation, and both can be called leverage. The first person might say, “We’re leveraged 50%”; the second person could say, “We’re leveraged 33%."

If someone mentions 'leverage' be sure to ask, “What do you mean by that?”  

 

Leverage Ratios

Liabilities

The liabilities of the company include bank Loans, salaries and benefits payable, suppliers’ bills (Payables), taxes due, etc.

Liabilities are usually sorted into Current Liabilities (short-term) falling due within one year) and Long-Term Liabilities where the payment period is greater than one year.

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

 

 

Liabilities

Liquid Assets

Calculation: Cash +  Receivables + Short-Term Investments.

Example: The Round Number Company

Cash = 10; Receivables = 20; Short-term Investments = 3

     Quick Assets =  10 + 20 + 3 = 33

Liquid Assets include the Current Assets that can quickly (and easily) be converted to cash.

Also called Quick Assets

 

Liquid Assets

Liquidity Ratios

Liquidity Ratios answer the question: "How well can the firm pay its liabilities that are coming due?"  They measure the ability of a firm to meet Short-term financial obligations.

Current Ratio (Working Capital Ratio): Compares Current Assets to Current Liabilities.

Acid-Test Ratio (Quick Ratio): Compares the ‘most liquid’ Current Assets to Current Liabilities.  The most liquid assets are Cash, Receivables and Short-term Investments.

Cash Ratio: Compares Cash to Current Liabilities. This is a “conservative” ratio because it counts only cash as liquid.

 

Loans

Money that is borrowed from a bank or other financial institution that must be paid back with interest and within a given period of time.  On the Balance Sheet, the word ‘Debt’ is commonly used to classify Loans.

 

Loans

Long-term Debt

Long-term Debt is the portion of Long-Term Liabilities that is related to borrowing money (i.e. bank Loans).  It is interest-bearing, and it is initially taken for a period greater than 1 year.  

However, the Current Portion Of Long-Term Debt (i.e. that portion falling due within 12 months of the Balance Sheet date) is reclassified as Short-Term Debt because the repayment is an immediate concern.

Short-Term Debt falls due within the current fiscal year (or less than 12 months in the future). 

 

Long-term Debt

Long-Term Investments

Long-term deposits, bonds and securities; they are not readily converted into Cash. 

 

Long-Term Investments

Long-Term Liabilities

Long-term Liabilities are the financial obligations of a company that are falling due more than one year in the future. They include Long-term Debt (i.e. loans) and Pensions & Other Post-Employment Benefits (OPEB). 

 

 

Long-Term Liabilities

M

Margin

This number describes the percentage of income which is left over after Costs & Expenses are deducted from Sales.

People will think of profit margin at different points on the Income Statement.  Production might look at Gross Margin; operations might look at Operating Margin; the finance department looks at Return on Sales.  See the different examples of Margins below:

     GROSS MARGIN

     Ratio: Gross Profit as a percentage of Sales

Example: The Round Number Company

Sales = 100; Gross Profit = 60,

     Gross Margin = 60/100 = 60%

    

     OPERATING MARGIN

     Ratio: Operating Income as a percentage of Sales

Sales = 100; Operating Income = 24, 

     Operating Margin = 24/100 = 24%

    

     RETURN ON SALES (ROS)

     Ratio: Net Income as a percentage of Sales

Sales = 100; Net Income = 15,

     Return On Sales = 15/100 = 15%

“What do you mean by that?”

Some people use Margin to mean the same as Gross Profit.

 

Margin

N

Net Asset

“What do you mean by that?”

Any term which uses the phrase ‘net asset’ or ‘net assets’ must be examined closely.  This term can describe wildly different situations - here are some possibilities:

  1. Net Assets are that portion of Total Assets funded by Corporate HQ i.e. Long-term financing and Capital Stock. This definition is used in the Return on Net Assets calculation. These Net Assets do not include assets generated by the managers activities (i.e. funded by Payables and some Other Current Liabilities).

Calculation: Total Assets less Payables and Other Current Liabilities

Example: The Round Number Company

Total Assets = 150; Payables = 10, Other Current Liabilities = 4

     Net Assets = 150 - 10 - 4 = 136

 

2. A different definition is used in the Net Asset Balance Sheet).

Calculation: Total Assets less Total Liabilities.

Example: The Round Number Company

Total Assets = 150; Total Liabilities = 80

     Net Assets = 150 - 80 = 70

3. A third definition is Net Asset Value (NAV) which is also called Book Value.

Calculation: Total Assets less Intangible Assets less Total Liabilities

Example: The Round Number Company

Total Assets = 150; Intangibles = 4; Goodwill = 10; Liabilities = 80

     Net Assets = 150 - 4 - 10 - 80 = 56

Make sure you agree on the meaning!

 

Net Asset Balance Sheet

A Balance Sheet balancing the Total Assets less non-interest bearing liabilities against the combined total of Interest-Bearing Liabilities and equity. The Net Asset Balance Sheet has advantages for measuring management performance, and is prevalent outside North America. See also Total Asset Balance Sheet. What do you mean by that? Any term which uses the phrase ‘net asset’ or ‘net assets’ must be examined closely. See Net Asset; Net Assets.

 

Net Asset Balance Sheet Net Asset Balance Sheet

Net Asset Turnover

Ratio: Sales divided by Net Assets

where Net Assets = Total Assets less Current Liabilities 

Example: The Round Number Company

Sales = 100; Total Assets = 150; Current Liabilities = 18

     Net Asset Turnover = 100/(150 - 18) = 100/132 = 62%

This is an ‘operating ratio’; it measures the efficiency of the assets employed. Like Asset Turnover, it shows the speed with which an amount of cash, equivalent to the money invested in the business by head office, comes back in through the door in fresh sales. It isn’t concerned with profit, only with cash flow. If sales are rapid, little cash is tied up to keep the business going; which may make it easier to expand.

Companies using Return on Net Assets (RONA) rather than Return on Assets (ROA) are likely to use Net Asset Turnover rather than Asset Turnover.

“What do you mean by that?”

See the discussion of Net Assets

See also Income|Outcome Triangle for Ratio Analysis

 

Net Asset Value

Calculation: Total Assets less Intangible Assets less Liabilities.

This is the amount of cash you would have if everything owned by the business was sold, and all debts were paid. It is a very conservative ‘worst-case’ valuation of what a business would be worth if it had to close down.

Be sure to ask, "What do you mean by that?" Any term which uses the phrase ‘net asset’ or ‘net assets’ must be examined closely.

See Net Asset; Net Assets.

 

Net Assets

Calculation: Total Assets less Non-Interest Bearing Liabilities Net Assets are that portion of Total Assets funded by Corporate HQ long-term financing and share capital.

 

Net Income

Net Income calculation: Sales less all Costs & Expenses

Return on Sales ratio: Net Income as a percentage of Sales

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36; Finance = 4; Tax = 5; the adjustments cancel out

     Net Income = 100 - 40 - 36 - 4 - 5 = 15

     Return on Sales = 15/100 = 15 %

 

Net Income is the amount of Profit left for the owners, after all costs and expenses, including interest and taxes, have been paid.

Return on Sales is proportion of Profit to Sales, it is the Profitability of the business.

Net Income is also known as Earnings or Profit or Net Profit or the "Bottom Line".

Return on Sales is also known as Profitability or the Profitability Ratio

 

Net Income Net Income

Net Present Value (NPV)

NPV is used to determine when, if ever, a capital investment will generate a profit, and how much that will be in today’s terms. Cash Flows of future years are discounted because ‘cash next year’ is worth less than ‘cash this year’ for a variety of reasons (inflation, risk, etc. ).  See for example, this NPV Calculator.

 

Net Profit

Calculation: Sales less all Costs & Expenses

Return on Sales ratio: Net Profit as a percentage of Sales

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36; Finance = 4; Tax = 5; (the adjustments of +5 and -5 cancel out)

     Net Profit = 100 - 40 - 36 - 4 - 5 = 15

    Return on Sales = 15/100 = 15%

Net Profit is the amount of Profit left for the owners, after all costs and expenses, including interest and taxes, have been paid.

Return on Sales is proportion of Net Profit to Sales, it is the Profitability of the business.

Net Profit is also known as Earnings or Profit or Net Income or the "Bottom Line".

Return on Sales is also known as Profitability or the Profitability Ratio

 

Net Sales

Calculation: Gross Sales at list price less discounts, sales returns and allowances, but before subtracting the Cost of Sales and Operating Expenses.

Sales is the revenues from the sale of goods and services which are part of the company’s regular operations. (Non-operating revenues, e.g. the sale of surplus equipment, would show up as an Adjustment rather than Sales Revenue.)

“What do you mean by that?”  

The term ‘Sales’ generally refers to Net Sales.  The term ‘Total Sales’ could refer to Gross Sales or Net Sales.  

Net Sales is the number used in Financial Statements if the line item just says ’Sales.’

 

Net Working Capital

Net Working Capital is the cash needed to run the business on a day-to-day basis--to maintain inventories and pay expenses. 

Calculation: Current Assets less Current Liabilities.   

Example: The Round Number Company

Current Assets = 66; Current Liabilities = 18

     Net Working Capital = 66 - 18 = 48

Net Working Capital does not include machinery, land or buildings (those are Fixed Assets needed to run the business). Rather, it’s the rhythmic needs of the business: inventory building up then being sold, waiting on money to come back in from sales, paying bills, renewing inventories, and starting all over again.

Also called Working Capital

See also non-Cash Net Working Capital.

See discussion of Working Capital on the Income|Outcome Blog.

 

Net Working Capital

Net Worth

The ownership the shareholders have in the company, represented by the Capital Stock, Retained Earnings, and other.

Also called Equity or Shareholders’ Equity.

 

Net Worth

Non-Cash Net Working Capital

Calculation:  Current Assets less Cash less Current Liabilities.   

Example: The Round Number Company

Cash = 10; Current Assets = 66; Current Liabilities = 18

     non-Cash Net Working Capital = 66 - 10 - 18 = 38

See also Net Working Capital.

See discussion of Working Capital on the Income|Outcome Blog.

 

Non-Cash Net Working Capital

O

Operating Expense

Opex or Operating Expense is the after-COS expenses related to normal operation of the business including R&D, advertising, salaries, and rent.  Depreciation may, or may not, be included in OpEx. 

Operating Expenses do not include Finance Charges, Taxes, and exceptional (one-time) charges. 

Note: OpEx is an Operating Expense on the Income Statement. CapEx is a Capital Expenditure on the Balance Sheet.

The terms Overhead, Operating Expense, Indirect Costs, and Fixed Costs are very similar. Check how each term is used in your company. 

 

 

Operating Income

Operating Income calculation: Sales less COS less Operating Expense

Operating Margin ratio: Operating Income as a percentage of Sales.

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36

     Operating Income = 100 - 40 - 36 = 24

     Operating Margin = 24/100 = 24 %

Operating Income is the amount of Profit available after deducting from Sales the costs associated with the operations of the company (Cost of Sales, Operating Expenses), but before paying finance charges and taxes.

Operating Margin is the portion of Sales that remains after covering the Direct Costs and Operating Expenses.

Operating Income is considered a useful management measure because it considers the revenue and expenses that are the manager's responsibility, but does not take into account the finance expense and taxes (which managers do not control).

Note: In the above example, Operating Income and Operating Margin have the same value but it is because we have been using round numbers based on Sales of 100 - this is not real-world.  

Example:  

Sales = 200; COGS = 90; OpEx = 36 

     Operating Income = 200 - 90 - 36 = 74

     Operating Margin = 74/200 = 37 %

“What do you mean by that?”

Operating Income is one of many possible finance terms for the same concept. It can also be known as:

 

Operating Income Operating Income

Operating Margin

Operating Income calculation: Sales less COS less Operating Expense

Operating Margin ratio: Operating Income as a percentage of Sales.

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36

     Operating Income = 100 - 40 - 36 = 24

     Operating Margin = 24/100 = 24 %

Operating Income is the amount of Profit available after deducting from Sales the costs associated with the operations of the company (Cost of Sales, Operating Expenses), but before paying finance charges and taxes.

Operating Margin is the portion of Sales that remains after covering the Direct Costs and Operating Expenses.

Operating Income is considered a useful management measure because it considers the revenue and expenses that are the manager's responsibility, but does not take into account the finance expense and taxes (which managers do not control).

Note: In the above example, Operating Income and Operating Margin have the same value but it is because we have been using round numbers based on Sales of 100 - this is not real-world.  

Example:  

Sales = 200; COGS = 90; OpEx = 36 

     Operating Income = 200 - 90 - 36 = 74

     Operating Margin = 74/200 = 37 %

“What do you mean by that?”

Operating Income is one of many possible finance terms for the same concept. It can also be known as:

 

Operating Margin

Operating Profit

Operating Profit calculation: Sales less Cost of Sales (COS) less Operating Expense

Operating Margin ratio: Operating Income as a percentage of Sales.

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36

     Operating Profit = 100 - 40 - 36 = 24

     Operating Margin = 24/100 = 24 %

Operating Profit is the amount of Profit available after deducting from Sales the costs associated with the operations of the company (Cost of Sales, Operating Expenses), but before paying finance charges and taxes.

Operating Margin is the portion of Sales that remains after covering the Direct Costs and Operating Expenses.

Operating Profit is considered a useful management measure because it considers the revenue and expenses that are the manager's responsibility, but does not take into account the finance expense and taxes (which managers do not control).

Note: In the above example, Operating Profit and Operating Margin have the same value but it is because we have been using round numbers based on Sales of 100 - this is not real-world.  

Example:  

Sales = 200; COGS = 90; OpEx = 36 

     Operating Profit = 200 - 90 - 36 = 74

     Operating Margin = 74/200 = 37 %

“What do you mean by that?”

Operating Profit is one of many possible finance terms for the same concept. It can also be known as:

 

Operating Profit

Operating Ratio

Ratio: (Cost of Sales (COS) + Operating Expense) as a percentage of Sales.

Example: The Round Number Company

Sales = 100; COS = 40; OpEx = 36 

     Operating Ratio = (40 + 36) / 100  = 76 %

The Operating Ratio is a comprehensive measure of a company's operational efficiency.

Lower ratios are generally favorable, indicating better cost management and higher efficiency in generating profit from sales.

“What do you mean by that?”

The terms Operating Ratio and OpEx Ratio are very similar - but they are different measurements!

 

Operating Ratio

OpEx Ratio

Ratio: Operating Expense as a percentage of Sales

Example: The Round Number Company

Sales = 100; OpEx = 36

     OpEx Ratio = 36/ 100  = 36 %

The OpEx Ratio measures the proportion of revenue spent on operating expenses.

“What do you mean by that?”

The terms Operating Ratio and OpEx Ratio are very similar - but they are different measurements!

 

OpEx Ratio

Other Current Assets

The accumulation of any Current Assets which are not detailed by individual class on the Balance Sheet.

These are liquid assets (meaning they are easily converted to Cash) but they do not include Cash and Marketable Securities, Receivables, Inventories, or Prepaid Expenses.

What is included in 'Other' will vary by company--look at the Notes to the Financial Statements. 

 

Other Current Assets

Other Current Liabilities

The accumulation of any Current Liabilities which are not detailed by individual class on the Balance Sheet.

What is included in 'Other' will vary by company--look at the Notes to the Financial Statements.

 

Other Current Liabilities

Other Fixed Assets

The accumulation of Fixed Assets which are not detailed by individual class on the Balance Sheet.

What is included in 'Other' will vary by company--look at the Notes to the Financial Statements.

 

Other Fixed Assets

Other Long-Term Liabilities

The accumulation of any Long-Term Liabilities which are not detailed by individual class on the Balance Sheet.

What is included in 'Other' will vary by company--look at the Notes to the Financial Statements.

 

Other Long-Term Liabilities

Overhead(s)

The after-COS expenses related to normal operation of the business including R&D, advertising, salaries, rent and utilities, but excluding interest expense, taxes, and exceptional (one-time) charges. 

“What do you mean by that?”

Overheads may also be attributable to specific areas or operations of the business, e.g. Factory Overheads.

Generally Overheads can also be called Operating Expense or OpEx.  See discussion at Costs & Expenses.

The terms Overhead, Operating Expense, Indirect Costs, and Fixed Costs are very similar. Check how each term is used in your company. 

 

Overhead(s)

P

P/E Ratio

Ratio: Price per Share divided by Earnings Per Share (EPS). This is the number of years it will take for the investment to be paid back by Earnings (i.e. Profit) at the current rate, and thus reflects the confidence that investors feel in the company.

 

Payables

Money you owe to your suppliers and vendors. Part of Current Liabilities.

Also called Accounts Payable or A/P

Called Creditors outside North America.

 

Payables

Pensions & Other Post-Employment Benefits (OPEB)

Pensions & OPEB include long-term obligations to retired employees. This can include pensions, insurance and other benefits.

Part of Long-Term Liabilities

 

Pensions & Other Post-Employment Benefits (OPEB)

PP&E

Property, Plant & Equipment: Tangible Assets such as land, buildings and machinery. These are Fixed Assets and are often combined into a single line-item on the Balance Sheet.

 

PP&E

Prepaid Expenses

Prepaid Expenses are expenses which have been paid in advance but have not yet been recorded as an expense. 

 

Prepaid Expenses

Price/Book Value Ratio

Ratio: Price per Share divided by Book Value Per Share.

This is a measure of the safety of an investment: how well is the investment covered by assets if the worst things happen and the company closes operations?

 

Profit

Profit can mean different things to different people.

     GROSS PROFIT

     Calculation: Sales less COS

     OPERATING PROFIT

     Calculation: Sales less COS less Operating Expense

     NET PROFIT

     Calculation: Sales less all Costs and Expenses

Net Profit is also called Net Income or 'the bottom line'.

The most common meaning of 'Profit' is Net Income - the income that is left over after all expenses (COGS, operating expenses, interest, and taxes) are deducted from sales. 

See discussion at Profit & Cash

 

Profit

Profit & Cash

Understanding the Cash Flow of a business is as essential as understanding Profit

Income|Outcome Learning

Profit is like food: you need it for the business to grow and to be healthy and strong; but you don’t have to eat all the time. But Cash is like air – you need it constantly.  If you run out, and cannot immediately get more, you die. 

Profit happens on the Income Statement. Cash Flow happens on the Balance Sheet.

 

 

Profit & Cash

Profit & Loss (P&L)

The Profit or Loss for the period, as reflected on the Income Statement.

Income Statement Equation: Sales Revenue – Expenses = Profit

‘The P&L’ is also used as another name for the Income Statement.

 

Profit & Loss (P&L)

Profit & Loss (P&L)

The Profit or Loss Statement (the ‘P&L’) is another name for the Income Statement.

It is a summary of the Sales income and expenses for the company over the operating period – a financial history book for the fiscal period (month, quarter, year). 

The Income Statement in the Annual Report shows the total income and expenses (and the profit or loss) for the business over the entire business year.   

Profit (or loss) is shown at the bottom line of the Income Statement.   

 

Income Statement Equation: Sales Revenue – Expenses = Profit

 

The left side of the Visual Finance graphic is an Income Statement.

Also known as the ‘P&L’ or a Profit and Loss Statement.

 

Profit Margin

Profit Margin looks at how much of Sales revenue remains as profit after all costs and expenses are paid.

Gross Margin

Ratio: Gross Profit as a percentage of Sales

Operating Margin

Calculation: Operating Income as a percentage of Sales

Profitability or Return on Sales(ROS)

Calculation: Net Income as a percentage of Sales

People will think of profit margins at different points on the Income Statement.  Production might look at Gross Margin while operations might look at Operating Margin; the Finance Department looks at Return on Sales.

“What do you mean by that?”

We use ‘margin’ to denote a percentage (of Sales).  Some people use ‘margin’ to mean the same as Contribution. Other people use it to mean the same as Gross Profit.

 

Profitability or Profitability Ratio

Ratio: Net Income as a percentage of Sales.

 

Ratio: Net Income as a percentage of Sales

Example: The Round Number Company

Sales = 100; COGS = 40; OpEx = 36; Finance = 4; Tax = 5

(The adjustments cancel out)

     Net Income = 100 - 40 - 36 - 4 - 5 = 15

     Return on Sales = 15/100 = 15 %

 

Also called Return On Sales (ROS).

See also Income|Outcome Triangle for Ratio Analysis.

 

Property, Plant & Equipment (PP&E)

Tangible Assets such as land, buildings and machinery. These are Fixed Assets and are often combined into a single line-item on the Balance Sheet.

 

Property, Plant & Equipment (PP&E)

Q

Quick Assets

Quick Assets calculation: Cash +  Receivables + Short-term Investments.

Quick Ratio: Quick Assets divided by Current Liabilities 

Example: The Round Number Company

Cash = 10; Receivables = 20; Short-term Investments = 3

     Quick Assets =  33

Current Liabilities = 18

     Quick Ratio =  33/18 = 1.8

Quick Assets include the Current Assets that can quickly (and easily) be converted to cash.

The Quick Ratio is a variant of the Current Ratio; it only includes items which are quickly (and easily) converted into cash.

“What do you mean by that?”

Another definition of Quick Assets is: Current Assets less Inventories.  This definition includes Prepaid Expenses but they are not always quickly converted to Cash.

 

Quick Assets Quick Assets

Quick Ratio

Quick Assets calculation: Cash +  Receivables + Short-term Investments.

Quick Ratio: Quick Assets divided by Current Liabilities 

Example: The Round Number Company

Cash = 10; Receivables = 20; Short-term Investments = 3

     Quick Assets =  33

Current Liabilities = 18

     Quick Ratio =  33/18 = 1.8

Quick Assets include the Current Assets that can quickly (and easily) be converted to cash.

The Quick Ratio is a variant of the Current Ratio; it only includes items which are quickly (and easily) converted into cash.

“What do you mean by that?”

Another definition of Quick Assets is: Current Assets less Inventories.  This definition includes Prepaid Expenses but they are not always quickly converted to Cash.

 

Quick Ratio

R

Raw Materials

Materials purchased for manufacture, not yet altered by the production process.

 

Raw Materials

Receivables

Money your customers owe to you. Part of Current Assets.

Also called Debtors outside North America. 

 

Retained Earnings

The accumulation of Net Income that has been paid kept in the company to help it grow (rather than being paid out to Shareholders as Dividends).

 

Retained Earnings

Return On Assets (ROA)

Ratio: Net Income as a percentage of the Total (average) Assets. ROA measures how effectively the assets are employed in the business. See also Income|Outcome Triangle for Ratio Analysis; Return on Net Assets (RONA).

 

Return On Assets (ROA)

Return On Capital Employed (ROCE)

Ratio: Operating Income as a percentage of Equity plus Long-term Debt. The precise definition will vary by company. Also known as Return on Net Assets (RONA).

 

Return On Equity (ROE)

Ratio: Net Income as a percentage of the Shareholders’ Equity. ROE measures how effectively the Shareholders’ investment has been put to work to create profit. Also known as Return on Investment.

 

Return On Equity (ROE)

Return on Investment

1. Investor’s View Ratio: Net Income as a percentage of the Shareholders’ Equity. ROI measures how effectively the Shareholders’ investment has been put to work to create profit. Also known as Return On Equity (ROE). 2. Manager’s View The benefit obtained from any internal improvement or expansion, expressed as a percentage of the cost. This ROI forecast allows the Finance Department to choose between competing proposals for improving the business, by seeing which ones provide the biggest bang for the buck.

 

Return on Net Assets (RONA)

Ratio: Operating Income as a percentage of the Net Assets RONA shows the profit that managers are making as a percentage of the assets given them to manage. Net Assets in this sense means the amount of Assets derived from Equity and long-term debt. Net Assets does not include supplier Payables and other liabilities which the managers have generated themselves. Similarly, Operating Income does not take into account the finance charges and taxes; i.e. the items that managers have no control over. See also Return On Assets (ROA).

 

Return On Sales (ROS)

 

Return on Sales is the Profitability ratio - it shows the portion of each sale that 'drops to the bottom line' as Profit. 

Net Income is he Profit left for the owners, after all costs, expenses, interest and taxes have been paid. 

Return On Sales (ROS) ratio: Net Income as a percentage of Sales 

Example: The Round Number Company

Sales = 100; Net Income = 15

     Return on Sales = 15/100 = 15%

 

Alternatively, ROS may be measured using Operating Income instead of Net Income; companies that measure performance using RONA will use this metric.  In this instance, ROS shows the percentage of the sales dollars that are left after you have paid the Operating Expenses (COGS, overheads, SG&A), and does not include Finance Charges, Income Tax and Adjustments.

Part of Income|Outcome Triangle for Ratio Analysis. See also Return On Assets (ROA) and Asset Turnover (ATO) .

Also known as Profit Margin or Profitability.

 

 

Return On Sales (ROS)

Revenues

Money flowing into the business from the Sales of goods and services (i.e. part of the regular business operation) OR from Adjustments (non-operating sources of revenue such as investing, sale of assets, foreign exchange).

 

Revenues

S

Sales

Revenues from the sale of goods and services which are part of the company’s regular operations. What do you mean by that? The term ‘Sales’ generally refers to Net Sales which is the number used in the Financial Statements. The term ‘Total Sales’ could refer to Gross Sales or Net Sales.

 

Selling, General & Administrative (SG&A)

The general expenses of running the business which are not associated directly with the products or services, i.e., the costs for sales and marketing, administration, recruitment and training and rent. Research and Development (R&D) may be included or may be broken out as a separate line item.

 

Selling, General & Administrative (SG&A)

Semi-Variable Cost

First make sure you understand the concept behind the terms Fixed Cost and Variable Cost, then ask “What do you mean by that?”

The terms Fixed Costs and Variable Costs look at the behavior of the costs - do the costs vary with Sales Volume?

Semi-Variable costs do vary with Sales Volume but they do so in ‘steps’.

There are 2 kinds of Semi-Variable Costs:

The first type of Semi-Variable Cost remains constant over a range of production and then steps up a level (also known as stepwise variable). This could be due to adding a new production machine (maintenance costs will increase) or adding a new location to a retail chain (rent will increase).  Depreciation is a kind of Semi-Variable Cost.

The second type of Semi-Variable Cost starts at a base level in a fixed manner, then increases in a variable manner. An example is a power bill, where there is a monthly connection fee and then a variable cost for usage.

Semi-Variable Costs are Operating Expenses. The reporting of these costs will vary by company - some or all of these costs can be:

 

Shareholders’ Equity

See Equity.

 

Shareholders’ Equity

Shares at Par Value

The face value of the capital shares, at their original declared value. This is normally far lower than the market price of the shares.

 

Short-Term Debt

Short-term Debt is the portion of Current Liabilities that is related to borrowing money (i.e. interest bearing bank loans) and is falling due within the fiscal year (or within the next 12 months).

Short-term Debt includes the Current Portion of  Long-term Debt which is coming due within the year.

Also called Current Debt.

 

Short-Term Debt

Short-Term Debt

Short-term Debt is the portion of Current Liabilities that is related to borrowing money (i.e. interest bearing bank loans) and is falling due within the fiscal year (or within the next 12 months).

Short-term Debt includes the  Current Portion of  Long-term Debt which is coming due within the year.

Also called Current Debt.

 

Short-Term Debt

Short-Term Investments

Marketable Securities (e.g. bonds and deposits) which are not included in Cash, but can be readily converted into cash.

 

Short-Term Investments

Site Overheads

Factory Overheads are costs that are connected directly to the production of goods and services but they are not identified as labor or materials. Examples include Depreciation of equipment at a production site, rent for a retail site, utilities for locations other than corporate offices.

The reporting of these costs will vary by company - some or all of these costs can be:

Admin Overheads are not directly connected to the production of goods and services, they are reported in Selling, General & Administrative (SG&A)

Site Overheads might be called Factory Overheads in manufacturing.

See also Direct Cost, Semi-variable Costs.

 

Statement of Cash Flow

Analysis of sources of cash that flowed into the business together with how cash was allocated, for the accounting period. The information is grouped by functional department, because Cash can be freed up from anywhere (such as getting customers to pay faster, or paying suppliers more slowly), not just from Sales or the Finance Department. Note: Cash Flow does not consider non-cash items such as depreciation.

 

Statement of Changes in Shareholders’ Equity

A summary of the changes in the Equity section of the Balance Sheet from year to year.

 

Stock

Typically means shares (e.g. Shareholder Equity). In other countries, it is more likely to mean Inventory.

 

Stock

T

Tangible Assets

Fixed Assets with a physical, tangible nature such as land, buildings, equipment and furniture. See also Intangible Assets.

 

Tangible Assets

The Company Board

A 3-dimensional landscape of the financial results of a business developed by Andromeda Training, Inc.

 

The Company Board

Total Asset Balance Sheet

A Balance Sheet balancing the total Assets against the combined total of Liabilities and Equity.

This is the simplest representation of Balance Sheet information, and is prevalent in North America. It shows the Assets (what you have in the business) and balances that amount against the total of Liabilities and Equity (which is where the assets came from). In other words, everything you have in the business comes from investing (Capital Stock), making money (Retained Earnings ), or borrowing from sources such as banks (Loans) and suppliers (Payables) ). See also Net Asset Balance Sheet.

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

 

 

 

Total Assets

The combined total of Current Assets and Fixed Assets.

 

Total Sales

Revenues from the sale of goods and services which are part of the company’s regular operations. What do you mean by that? The term ‘Sales’ generally refers to Net Sales which is the number used in the Financial Statements. The term ‘Total Sales’ could refer to Gross Sales or Net Sales.

 

V

Variable Costs

A cost that varies with the Sales volume. Examples are materials, labor, and sales commission. Conceptually, Direct Cost, Cost of Sales (COS) or Cost of Goods Sold (COGS) and Variable Costs are very similar. Check how each term is used in your company.

 

Variance

The difference between the expected or planned result and the actual result.

 

Visual Finance

See https://visualfinanceweb.com/

 

W

What do you mean by that?

The definitions given here are our generic explanations of common corporate financial terminology. Actual meanings can vary wildly from company to company; in order to have the correct internal definition you need to ask your Finance Department, "What do you mean by that?"

 

Work-in-Process (WIP)

Goods that are in the production stage, to be finished at some future date for shipment to customers.

 

Work-in-Process (WIP)

Working Capital

Calculation: Cash, Accounts Receivable, and Inventory minus the Payables and other short-term financing obtained in relation to the Current Assets. What it takes to run the business on a day-to-day basis. Defined as the difference between Current Assets and Current Liabilities. Also known as Net Working Capital.

 

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