Finance Glosory

ACID-TEST RATIO
A meaure of the ability of a business to meet its short-term commitments. It is calculated by dividing current assets, excluding stock, by current liabilities. Current assets are trade debtors (amounts due from customers), cash balances, and short-term investments which can easily be convertered into cash. Current liabilities include amounts due to suppliers, bank overdrafts and amounts due for unpaid expenses such as telephone bills and PAYE.
ACCOUNTING EQUATION
This states that total assets equal total liabilities.
ACCRUALS OR ACCRUED CHARGES
Expenses for the current accounting period which have not yet been paid. They are sometimes referred to as provisions. Accrued income refers to cash received in advance for a service not yet provided to the customer.
ASSETS
The economic resources of a business such as buildings, equipment, trade debtors and cash balances.
ASSET TURNOVER
This is a ratio which measures the effectiveness with which a business uses its assets in relation to the level of income or sales, (turnover), which they generate. It is calculated by dividing income by capital employed.
ASSOCIATED OR RELATED COMPANY
A company over which another has significant influence. A company will be presumed to be an associated company if it is owned to the extent of between 20% and 50%. Above 50% ownership it becomes a subsidiary. Under 20% ownership it becomes a trade investment.
BALANCE SHEET
A statement of the financial position of a business at a particular date showing the various categories of assets and how they have been financed.
BOOK VALUE (or net book value or written down value)
The cost of a fixed asset such as plant and equipment less the depreciation which has so far been accumulated.
CAPITAL (Share Capital)
The permanent capital contributed by the owners of a business (the shareholders), both at the start of trading and subsequently, when additional capital is required to finance expansion.
CAPITAL EMPLOYED
This is equal to fixed assets plus current assets, less current liabilities. Companies sometimes use the term "net assets" when referring to capital employed.
CAPITAL EXPENDITURE
Expenditure on fixed assets such as plant and equipment, the cost of which is spread over several accounting periods through the process of depreciation. The cost of the fixed assets (less the depreciation accumulated to date) is "capitalised" in the balance sheet. The depreciation charged each year is a cost in the profit and loss account.
CAPITAL GEARING OR GEARING
The proportion of total bank borrowings in relation to capital employed.
CAPITAL AND RESERVES
The sum of the share capital, the share premium, the retained profit and other reserves at the balance sheet date. Other reserves may include "capital reserves" which arise from upward re-valuations of assets.
CASH FLOW
The ability of a business to generate liquid resources to meet its short-term and long-term commitments. Cash flow is often used synonymously with the term "funds flow".
COLLECTION PERIOD
The average length of time that it takes for a customer to pay a sales invoice. It is calculated by dividing trade debtors by income (or turnover), times 365 days to give the average number of days for which the sales invoice has been outstanding.
COST
The charge against profits made for the use or consumption of resources during an accounting period. It is not necessarily the same as the cash actually spent in view of adjustments for pre-payments and provisions.
COST OF SALES OR COST OF GOODS SOLD
This is the cost to the business of the products and services sold to its customers.
CREDITORS
Any person or organisation to whom a business has a commitment apart from shareholders (who own the business). For example, trade creditors are suppliers of goods for which unpaid bills are outstanding. It is a legal requirement to distinguish between short-term creditors (due to be paid within 12 months of the balance sheet date) called current liabilities, and long-term creditor is taxation. Short and long-term bank borrowings are disclosed separately.
CURRENT ASSETS
Assets such as debtors and stocks, which can be convertered into cash within 12 months of the balance sheet date. Cash balances and short-term investments (such as stock market investments), are also part of current assets.
CURRENT LIABILITIES
Short-term liabilities which have to be discharged normally within 12 months of the balance sheet date. For example, trade creditors, bank overdrafts and accrued charges.
CURRENT RATIO
The ratio of current assets divided by current liabilities. It is a broad measure of the ability of a business to meet its short-term commitments. Current assets less current liabilities are equal to net current assets or working capital.
DEBT OF FINANCE DEBT
Interest bearing liabilities such as short and long-term bank loans.
DEBT-EQUITY RATIO
The proportion of short and long-term bank borrowings less cash balances to the shareholders' equity or shareholders' funds.
DEFERRED INCOME (see also accrued income)
Cash received in advance of providing goods and services.
DEFERRED TAXATION
This is caused by timing differences which arise when a transaction is recognised differently for accounting purposes and tax purposes; for example, capital expenditure, which involves the process of depreciation for accounting purposes and the calculation of capital or investment allowances for tax purposes.
DEPRECIATION
The process of allocating the cost of a fixed asset over its expected commercial life.
DIRECT COSTS
Those costs which can be identified with a specific activity or product. Indirect costs are those costs which cannot be identified with a specific activity or product.
EARNINGS
The profit after taxation and all other charges less preference dividends and the minority interest but before extraordinary items. Earnings are attributable to the ordinary shareholders who are the owners of the business.
EARNINGS PER SHARE
The profit after taxation, and all other charges less preference dividends and the minority interest, but before extraordinary items, divided by the number of issued ordinary shares.
EXPENDITURE
Either (a) capital expenditure (see separate entry) or (b) revenue expenditure like rent, rates, salaries and wages which is charged or "written off" to the profit and loss account as soon as it is incurred.
EXTRAORDINARY ITEMS
Items which are both abnormal in size and in nature. They are not expected to occur frequently or regularly. For example, the nationalisation of assets held abroad. There are also exceptional costs which are abnormal in size but not in nature such as large provisions for bad debts.
FIFO (First-in-first-out)
A method of stock valuation under the Historical Cost convention based on the assumption that the items remaining in stock are those which were purchased most recently.
FIXED ASSETS
Assets used almost permanently in the business such as property, plant and equipment.
FUNDS FLOW
Any transaction which has or will have an effect on cash. Funds may be described as a measure of purchasing power since access to funds implies an ability to finance or pay for short and long-term expenditure.
GROSS PROFIT
The difference between income (or turnover) and the direct cost of providing the service.
HISTORICAL COST OR HISTORICAL COST CONVENTION
This is the traditional way of valuing assets in a balance sheet and costs in the profit and loss account. The criterion for valuation is the acquisition cost.
ILLIQUID
The opposite of liquid.
INTEREST COVER
An indicator of solvency: it is calculated by expressing profit before interest and taxation (the operating or trading profit) as a multiple of the net interest charge (interest payable less interest receivable).
LIABILITY
Amounts owned by the business to others. Total liabilities equal shareholders' funds plus amounts due to creditors.
LIQUIDITY
The ability of a business to meet its short-term commitments. If expansion is too rapid, trade debtors and stocks may increase to such an extent that creditors cannot be paid reasonably promptly because cash flow is inadequate. This is called over-trading.
LIQUID RESOURCES
Cash and bank balances plus short-term investments.
MINORITY INTEREST
The capital provided by, and earned for group shareholders who are not parent company shareholders. Many subsidiary companies are not fully owned by the parent company, although, the parent company's "stake" will be more than 50%. This means that they are partly owned by "minority" shareholders outside the group. In preparation of consolidated or group financial statements, accountants bring in 100 per cent of all the assets, expenses, liabilities and revenues of subsidiaries. This is because the group fully controls the subsidiary, even if it does not fully own it. The subsidiary is amalgamated into the rest of the group.
OPERATING COSTS
All costs excluding interest charges and taxation. They represent those costs most directly under the control of line or operating management. Income or turnover less operating costs equals operating or trading profit.
PAR VALUE
The nominal value of a company's shares.
PREPAYMENT
A cash payment which includes an amount covering a subsequent accounting period. For example, business rates paid in advance.
PROFIT
The difference between income, (or turnover), and costs for an accounting period. In view of the "matching" principle, it is not the same as cash, since revenue is recognised when goods or services are supplied (rather than when paid for by the customer) and costs are incurred during the time period to which they relate (rather than when they are paid out in cash).
PROFIT AND LOSS ACCOUNT (or Income Statement)
A summary of the income or turnover and costs for an accounting period. The profit and loss account is concerned with trading performance during a given period, whereas the balance sheet is concerned with the financial position at a particular date.
PROFIT MARGIN
A measure of profitability. It is defined as the profit before or after interest, and taxation expressed as a percentage of income or turnover.
PROVISION
An additional allowance for a cost or charge incurred but not paid for at the balance sheet date. It will be included as a cost in the profit and loss account and a liability in the balance sheet. See accruals and accrued charges.
RETAINED PROFIT
The profit for the year after all charges and the distribution of dividends to shareholders. The figure for retained profit in the balance sheet will be the accumulated retained profit since the business started to trade.
RETURN ON CAPITAL EMPLOYED (ROCE)
Normally defined as the profit before interest and taxation expressed as a percentage of the capital employed. It is a basic measure of profitability.
RETURN ON SHAREHOLDERS' EQUITY OR SHAREHOLDERS' FUNDS
The profit after all charges and the minority interest but before extraordinary items expressed as a percentage of shareholers' funds.
REVENUE (or income)
The same as turnover or sales which is the invoiced value of the goods and services provided to customers.
RIGHTS ISSUE
The sale of additional shares by a company to its existing shareholders (in proportion to their existing holdings), normally at a discount to the prevailing stock market price in order to ensure a successful issue.
SHAREHOLDERS' EQUITY OR SHAREHOLDERS' FUNDS
The sum of the share capital plus share premium plus retained profit plus other reserves, at the balance sheet date.
SHARE PREMIUM
The difference between the issue price and the nominal or par value of a share.
SOLVENCY
The ability of a business to meet its long-term commitments. See also the debt/equity ratio and interest cover.
STOCK TURNOVER RATE
The average number of times each year that stocks are "turned over" in the course of trading activity. It is calculated by dividing the sales or cost of sales by the average or closing stocks.
SUBSIDIARY COMPANY
See associated company.
TRADE CREDITORS
Amounts due to suppliers for goods and services received but not yet paid for. They are normally a current liability and are due for payment within 12 months for the balance sheet date.
TRADE DEBTORS
Amounts due from customers in respect of goods and services supplied but not yet paid for.
TRADING OR OPERATING PROFIT
Profit after all charges except interest and taxation.
TURNOVER
The value of goods and services provided to customers. Revenue or sales have the same meaning.
WORKING CAPITAL
Current assets less current liabilities (also called net current assets).