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

See Days Sales Outstanding (DSO) to see how quickly Receivables move into Cash. 

 

 

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.

 

     ATR = Quick Assets/Current Liabilities  

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

Example: The Round Number Company Cash = 20; Accounts Receivable = 40; [STI} = 6; Current Liabilities = 36      Quick Assets =  20 + 40 + 6 = 66     ZATR =  66/36 = 1.8

 

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.

 

 

Adjustments are Revenues and Expenses, reported on the Income Statement, 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. 

 

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).

 

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

     Asset Turnover = Sales/Assets

Example: The Round Number Company Sales = 200; Assets = 300 Asset Turnover (ATO) = 200/300 = 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.

Asset Turnover is also called Asset Turns.

See also Net Asset Turnover.

 

Calculator for Asset Turnover  Asset Turnover = Sales/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.

 

The Average Collection Period ratio shows how quickly the proceeds from  Sales(i.e. Accounts Receivable (A/R) ) are converted into Cash.  It is the average number of days to receive payment, this is shown on the Visual Finance graphic. 

     Average Collection Period = Accounts Receivable (A/R) /Average Daily Sales

     where Average Daily Sales = Sales/365

 

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:

• • Liabilities is the portion funded by others - borrowing from sources such as banks (Loans); or by acquiring inventories today, but paying suppliers in the future (Payables).
  • Equity is the portion funded by initial investing (Capital Stock), and by reinvesting profits in the company (Retained Earnings).

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 = Net Assets = 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.

 

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.

 

 

There are multiple definitions of Book Value, be sure to know which definition is being used.

“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 = 300; Intangibles = 20; Goodwill = 8; Liabilities = 160      Book Value Of Business = 300 - 20 - 8 - 160 = 112 If the Round Number Company has issued 200 shares;      Book Value per Share = 112/200 = 0.56

Note: Any term which uses the phrase ‘net asset’ or ‘net assets’ must be examined closely.  

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 = 300; Liabilities = 160      Book Value Of Business = 300 - 160 = 140 If the Round Number Company has issued 200 shares;      Book Value per Share = 140/200 = 0.7

Be sure to know which definition is being used!

 

which definition to use?

 

 

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.

 

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.

 

Targets and Budgets

A Target is a specific objective or goal that a business, or organization aims to achieve: sales revenue, a level of customer service, market share.  

A Budget is a detailed plan outlining expected income and expenditure over a set period, often as a means of achieving a specific target.   

 

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). 

Note: Capital is not the same as Capital Stock although some people might use the terms interchangeably.

 

“What do you mean by that?”  

There are multiple definitions for Capital Employed, understanding which definition is being used is critical.   

A common financial analysis metric is Return on Capital Employed (ROCE):  

Ratio: Operating Income as a percentage of Capital Employed.    

Most definitions of ROCE use Operating Income or EBIT as the 'return', but the precise definition of Capital Employed can vary by company.  

Here are six possibilities:

1. Calculation: Capital Employed = Shareholders' Equity + Long-Term Debt

Example: The Round Number Company Operating Income = 30; Shareholder Equity = 140; Long-Term Debt = 100      Return on Capital Employed = 30/(140 + 100) = 30/240 = 12.5 %

      2. Calculation: Capital Employed =  Total Assets - Intangible Assets - Current Liabilities

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

Operating Income = 30; Total Assets = 300; Intangibles = 8; Goodwill = 20; Current Liabilities = 36      Return on Capital Employed = 15/(300 - 8 - 20 - 36) = 30/236 = 12.7%

     3. Calculation: Capital Employed = Equity + Long-Term Liabilities 

Operating Income = 30; Shareholder Equity = 140; Long-Term Liabilities = 124      Return on Capital Employed = 30/(140 + 124) = 30/264 = 11.4 %

4. Calculation: Capital Employed = Total Assets - Current Liabilities. 

Operating Income = 30; Total Assets = 300; Current Liabilities = 36      Return on Capital Employed = 30/(300 - 36) = 30/264 = 11.4 %

     5. Calculation: Capital Employed = Fixed Assets + Working Capital.

where Working Capital = Total Current Assets - Total Current Liabilities

Operating Income = 30; Fixed Assets = 168; Current Assets = 132; Current Liabilities = 36      Working Capital = 132 - 36 = 96      Return on Capital Employed = 30/(168 + 96) =  30/264 = 11.4%

     6. Capital Employed = Total Assets - Current Liabilities - Cash and Cash Equivalents

Operating Income = 30; Total Assets = 300; Current Liabilities = 36; Cash = 20      Return on Capital Employed = 30/(300 - 36 - 20 ) =  30/244 = 12.3%

Definitions 3, 4, and 5 are different ways of expressing the same value.  An ROCE calculation using one of these definitions is equivalent to Return on Net Assets (RONA).

 

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.

 

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 although some people might use the terms interchangeably.

 

 

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

Cash drives the business!

Also called Cash On Hand or Cash & Equivalents.

 

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.

 

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 DPO = Days 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.

 

 

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.

 

 

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:

• If you are going to run out of cash.
• When you will run out of cash.
• How much cash you will need.
• How long you’ll need it for. There’s a big difference between being short $500 for two days, and being short $50,000 for six months.

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.

 

The Cash Flow Statement is 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:

Cash Flow from Operations + Cash Flow from Investing + Cash Flow 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.

 

Ratio: Cash divided by Current Liabilities

 

Contribution is what’s left from the Sales after allowing for the Direct Cost for goods and services (e.g. Cost of Sales or 'materials and labor'); it contributes toward paying for the overhead costs and expenses of the business.

Contribution Margin indicates the percentage of Sales that remains after covering the Direct Costs.

     Contribution = Sales - Cost of Sales (COS)  

     Contribution Margin = Contribution/Sales as a percentage 

Example: The Round Number Company Sales= 200, Cost of Sales (COS) = 80      Contribution = 200 - 80 = 120      Contribution Margin = 120/200 = 60%

“What do you mean by that?”  

Some people use the two terms (Contribution and Contribution Margin) interchangeably. 

Further, 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.

• If Factory Overheads are allocated to Cost of Sales (COS) or Cost of Goods Sold (COGS), Contribution and Gross Profit will be the same number.

• Alternatively, if the company first calculates Contribution as (Sales - Direct Costs); it will then subtract the Factory Overheads to calculate Gross Profit.

===

Calculator for Contribution AND Contribution Margin    Contribution = Sales - Cost of Sales (COS)        Contribution Margin = Contribution/Sales as a percentage

 

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%.

 

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.

 

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.

 

“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:

• • • Cost of Sales (COS) (Cost of Goods Sold (COGS), Direct Cost, Variable Cost)
    • Factory Overheads and Depreciation may be recorded above Gross Profit, see Note below.

     Costs & Expenses below Gross Profit and above Operating Income:

• • • Operating Expense (OpEx, Overheads, SG&A, Fixed Costs, Indirect Costs)

     Costs & Expenses below Operating Income (EBIT):

• • • Finance Expense
    • Income Tax
    • Adjustments

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.

 

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

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

 

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 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.

 

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.

 

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.

 

Ratio: Current Assets divided by Current Liabilities.

Example: The Round Number Company Current Assets = 132; Current Liabilities = 36      Current Ratio = 132/35 = 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.

 

 

 

Ratio: Inventory divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company COS = 80; Inventory = 50      Average Daily COS = 80/365 = 0.22      Days Inventory Outstanding = 50/0.22 = 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).

 

 

Ratio: Payables divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company COS = 80; Payables = 20      Average Daily COS = 80/365 = 0.22      Days Payable Outstanding = 20/0.22 = 91 Days

The ratio shows the company’s average payable period.

Days Payable Outstanding is part of the Cash Conversion Cycle.

 

 

Ratio: Receivables divided by the Average Daily Sales

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

Example: The Round Number Company Sales = 200; Receivables = 40      Average Daily Sales = 200/365 = 0.55      Days Sales Outstanding = 40/.55 = 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.

The Visual Finance graphic automatically shows the Days Sales in Receivables.  

 

 

Ratio: Inventory divided by the Average Daily COS

where Average Daily COS = (Annual COS/365)

Example: The Round Number Company COS = 80; Inventory = 55      Average Daily COS = 80/365 = 0.22      Days Sales Inventory = 50/0.22 = 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).

 

 

The Days Sales Outstanding ratio shows how quickly Receivables (i.e. the proceeds from Sales) are converted into Cash. It is the average number of days to receive payment.

Ratio: Receivables divided by the Average Daily Sales

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

Example: The Round Number Company Sales = 200; Receivables = 40      Average Daily Sales = 200/365 = 0.55      Days Sales Outstanding = 40/.55 = 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.

The Visual Finance graphic automatically shows the Days Sales in Receivables.  

See How Quickly do Accounts Receivable Move Into Cash?

this is automatically shown on the Visual Finance graphic.

     Days Sales Outstanding (DSO)  = Accounts Receivable (A/R) /Average Daily Sales

     where Average Daily Sales = Sales/365

Accounts Receivable is aso called Receivables. Often called Debtors outside North America. 

===

 

 

“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.

 

The debt ratio measures the extent of a company's leverage.

Debt Ratio: Total Liabilities/Total Assets

Utilities and manufacturing are 'capital-intensive industries', they are more likely to have higher debt ratios .  

Service companies are generally less capital-intensive and will have lower debt ratios. 

See the discussion at Leverage.

 

 

 

Ratio: Liabilities divided by Equity.

Example: The Round Number Company Total Liabilities = 160; Equity = 140      Debt-to-Equity = 160/140 = 1.14

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.

See also the discussion at Leverage.

 

 

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

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

 

 

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.)

 

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?

 

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.

 

 

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

Also called Factoring.

 

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.

 

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.

Dividend Cover ratio: Net Income divided by Dividends

Example: The Round Number Company The Round Number Company made a profit of 30, and the entire amount was added to Retained Earnings.  If instead the owners declare a Dividend of 10, then the Net Income is still 30, but the Addition To Retained Earnings is only 20.  (Payment of the Dividend would reduce Cash by 10, so the Balance Sheet will still balance.)      Dividend Cover = 30/10 = 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.

 

Calculation: Sales less all Costs and expenses

Example: The Round Number Company Sales = 200; COS = 80; OpEx = 72; Finance = 8; Tax = 10 (In this example, the Adjustments cancel out)      Net Income = 200 - 80 - 72 - 8 - 10 = 30

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. 

 

 

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

Example: The Round Number Company Sales = 200; COS = 80; OpEx = 72       EBIT = 200 - 80 - 72  = 48

 

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.

 

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

Example: The Round Number Company Sales = 200; COS = 80; OpEx = 72; Finance = 8      EBT = 200 - 80 - 72 - 8 = 40

 

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

Example: The Round Number Company Net Income = 30 If the Round Number Company has issued 200 shares,       Earnings per Share = 30/200 = 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.

 

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.

 

placeholder

 

“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:

• • • Cost of Sales (COS) (Cost of Goods Sold (COGS), Direct Cost, Variable Cost)
    • Factory Overheads and Depreciation may be recorded above Gross Profit, see Note below.

     Costs & Expenses below Gross Profit and above Operating Income:

• • • Operating Expense (OpEx, Overheads, SG&A, Fixed Costs, Indirect Costs)

     Costs & Expenses below Operating Income (EBIT):

• • • Finance Expense
    • Income Tax
    • Adjustments

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.

 

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

Also called Discounting Receivables.

 

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:

• included in Cost of Sales
• reported as a separate line item between Contribution and Gross Profit
• included in SG&A.

Admin Overheads are a different kind of overhead--they are not directly connected to the production of goods and services. Admin Overheads 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.

 

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

 

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:

• The Balance Sheet shows, at a specific point in time, the Assets (what you have in the business) and balances that against where the funding comes from: borrowing from sources such as banks (Loans) and suppliers (Payables), or from investing (Capital Stock), and from reinvesting profits in the company (Retained Earnings). The two totals must balance.

Balance Sheet Equation: Total Assets = Total Liabilities + Equity

• The Income Statement looks at how much money the business has made (Sales Revenue) and how much money it has spent (Costs and Expenses) over an operating period (month, quarter, year). The ‘bottom line’ of the Income Statement shows the profit or loss for the period.   

Income Statement Equation: Sales Revenue – Expenses = Profit

• The Cash Flow Statement is used to track the sources and uses of Cash; It is not concerned with Profit.  It looks at how Cash flows into and out of the business over an operating period (month, quarter, year).

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.

 

 

These are the actual financial results for Michelin's 2023 fiscal year, presented through our Visual Finance™ approach. If you'd like to see a simplified version of financial statements to help build your understanding, visit the Round Number Company page. For a step-by-step guide on interpreting Visual Finance, check out our How to Read Visual Finance page.

 

The Round Number Company is a fictional business we use to make financial concepts easy to see and understand. Our examples feature actual financial statements for the Round Number Company, with simplified figures to highlight key terms and calculations in our glossary. If you'd like to explore the financial statements of a real-world company, visit the Michelin page to see how these concepts apply to a global business.

 

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

 

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

• Variable Costs do vary with the Sales Volume. If Sales double from one month to the next, then the Cost of Sales will also double. Cost of Sales is a Variable Cost.

• Fixed Costs do not vary directly with Sales Volume; they are approximately the same from month to month (they are ‘fixed’). Examples include R&D, advertising, non-production personnel, training, and rent for the corporate offices.

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.

 

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.

 

 

Gross Profit calculation: Sales less Direct Cost 

Gross Margin ratio: Gross Profit as a percentage of Sales 

Example: The Round Number Company Sales = 200;  Cost of Sales  = 80      Gross Profit = 200 - 80 = 1200      Gross Margin = 120/200 = 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.

 

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

See also Sales; Net Sales.

 

 

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.

 

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).

There are also intermediate points that are called 'income': Gross Income (after subtracting the direct costs) and Operating Income (after subtracting direct costs and operating expenses).  

 

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.

 

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

 

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

(The Income|Outcome simulation game board design is similar to Visual Finance--it is a 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.)

 

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? 

 

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.