FINANCIAL DECISION MAKING FOR MANAGERS GLOSSARY A • ACCOUNTING: is the systematic and comprehensive recording of financial transactions pertaining to a business, and it also refers to the process of summarizing, analyzing and reporting these transactions to oversight agencies, tax collection entities and investors. • ACCOUNTING ADJUSTMENTS: accounting entries that do not have a direct impact on the cash account made at the end of the accounting period to ensure accounting records follow the accrual and matching principal. These are needed for transactions that imply or affect revenue or expenses for more than one accounting period. • ACCOUNTING RATE OF RETURN (ARR): is the amount of profit, or return, a person can expect based on the investment made. Accounting rate of return divides the average profit by the initial investment to get the ratio or return that can be expected. • ACCRUALS: revenues and expenses that have not yet been recorded but have arisen during the period. • ACCRUAL PRINCIPLE: you should record accounting transactions in the period in which they actually occur rather than the period in which the cash flows related to them occur; transaction has to have taken place – product or service should have been delivered, not necessarily the cash. • AMORTIZATION: paying off debt with a fixed repayment schedule over a period of time. • ASSETS: INVESTMENTS »» Current assets: cash, accounts receivable and inventory; we want to maximize their turnover or generate maximum revenue from minimum current assets. »» Fixed assets are the assets that help a company build value over time (ex: machinery, software patent). B • BALANCE SHEET: A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. In a nutshell it´s a snapshot of the financial affairs of a company. • BETA: is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of equity an asset based on its beta and expected market returns. C • CAPITAL EXPENDITURE ALSO KNOWN AS CAPEX: are funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. • CAPITAL: EQUITY + DEBT. • CAPITAL STRUCTURE: The capital structure is how a firm finances its overall operations and growth by using different sources of funds. • CASH FLOW STATEMENT: document that provides data regarding all cash a company receives as inflow and the outflow that pays for business activities and investments. • CASH ACCOUNTING: is an accounting method in which payment receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid. In other words, revenues and expenses are recorded when cash is received and paid, respectively. • CREDIT: sources of funds • CREDIT LINE: is an arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the lender permits the borrower to access or maintain over a period. D • DEBIT: is an accounting entry that results in either an increase in assets or a decrease in liabilities on a company’s balance sheet or the application of funds. • DEFERRALS: entries that have been recorded but that need to be divided between 2 or more accounting periods. • DEPRECIATION: allocates the cost of tangible assets. • DIVIDEND: a distribution of part of a company’s earnings paid to shareholders. • DISCOUNT RATE: is the interest rate charged to commercial banks for loans received from the Federal Reserve’s discount window. The discount rate also refers to the interest rate used in discounted cash flow analysis to determine the present value of future cash flows. • DIVIDEND DISCOUNT MODEL: The dividend discount model (DDM) is a procedure for valuing the price of a stock by using the predicted dividends and discounting them back to the present value at the cost of equity. • DOUBLE ENTRY: means that every financial transaction has equal and opposite effects in two accounts. E • EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION (EBITDA MARGIN): is a measurement of a company’s operating profitability as a percentage of its total revenue. It is equal to earnings before interest, tax, depreciation and amortization divided by total revenue. • EQUITY: value of an asset minus the liabilities of the asset. • EXTRINSIC VALUE: value assigned to an asset, project, or company for external reasons (usually the market). F • FINANCIAL ACCOUNTING: the business language when it comes to financial and economic affairs. G • GROSS PROFIT: is a financial metric used to assess a company’s financial health and business model by revealing the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). H • HISTORICAL COST: is a measure of value used in accounting in which the price of an asset on the balance sheet is based on its nominal or original cost when acquired by the company. I • INTEREST COVERAGE RATIO: The interest coverage ratio is a debt ratio used to determine how easily a company can pay interest on its outstanding debt. The interest coverage ratio may be calculated by dividing a company’s earnings before interest and taxes (EBIT) during a given period by the company’s interest payments due within the same period. I • INTEREST EXPENSE: An interest expense is the cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. It represents interest payable on any borrowings – bonds, loans, convertible debt or lines of credit. It is essentially calculated as the interest rate times the outstanding principal amount of the debt. Interest expense on the income statement represents interest accrued during the period covered by the financial statements, and not the amount of interest paid over that period. While interest expense is tax-deductible for companies, in an individual’s case, it depends on his or her jurisdiction and also on the loan’s purpose. • INTERNAL RATE OF RETURN: Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does. • INTRINSIC VALUE: how much an asset, project, or company is worth for us; this hinges on the amount of money we can draw from it. • IMPAIRMENTS: Impairment is an accounting adjustment that describes a permanent reduction in the value of a company’s asset, normally a fixed asset. J K L • LIABILITIES: company’s financial debt or obligations that arise during the course of its business operations. M • MATURITY MATCHING: a measure of whether the structural needs of funds, in terms of investments the company needs all the time to roll out strategy are being funded by resources that are also structural, therefore supporting the assets without risk of insolvency. • MATCHING PRINCIPLE: expenses = revenue; in measuring net income for a period, revenue should be offset by all expenses incurred in producing that revenue. Basically, cause and effect. N • NET INCOME (NI): is a company’s total earnings (or profit); net income is calculated by taking revenues and subtracting the costs of doing business such as depreciation, interest, taxes and other expenses. • NET PRESENT VALUE (NPV): is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting to analyze the profitability of a projected investment or project. O • OPERATING WORKING CAPITAL: is an operating metric and refers to the financial resources needed to finance the operation of current assets. »» OWC = ACCOUNTS RECEIVABLE + INVENTORY- ACCOUNTS PAYABLE – UNEARNED REVENUE • OPERATING WORKING CAPITAL: excludes cash, short-term financial investments and short term financial debt, for a better idea about the situation in the company. »» OPERATING WORKING CAPITAL = OPERATING CURRENT ASSETS – OPERATING CURRENT LIABILITIES P • PAYBACK PERIOD: The payback period is the length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions. • P & L OR PROFIT AND LOSS OR INCOME STATEMENT: Displays the Revenues and Expenses for a company at a given time, resulting in the Net Income. • PROVISION: is a legal clause or condition contained within a contract that requires one or both parties to perform a particular requirement by some specified time or prevents one or both parties from performing a particular requirement by some specified time. Q R • RETAINED EARNINGS: net earnings that are not paid out as dividends but kept by the company to be reinvested in business or pay debt • REVENUES = SALES • RETURN ON ASSETS (ROA) = is an indicator of how profitable a company is relative to its total assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company’s management is at using its assets to generate earnings. • RETURN ON EQUITY (ROE): is the amount of net income returned as a percentage of shareholders equity. • RETURN ON INVESTED CAPITAL (ROIC) = A calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments. Return on invested capital gives a sense of how well a company is using its money to generate returns. S • SHAREHOLDERS’ EQUITY: firms total assets minus its total liabilities; it represents the net value of a company. • SOLVENCY: the ability of a company to meet its long-term financial obligations. T • TOTAL SHARE RETURN: (END OF PERIOD PRICE + DIVIDENDS – BEGINNING OF PERIOD PRICE) / ( BEGINNING OF PERIOD PRICE) »» Return made over that given share/the beginning share price U V W • WORKING CAPITAL: Working capital is a measure of both a company’s efficiency and its short-term financial health. X Y Z BILIOGRAPHY www.investopedia.com www.corporatefinanceinstitute.com
