Dictionary of Key Terms and Concepts
Accounting earnings
The difference between recognized revenues and expenses during an accounting period, based on generally accepted accounting principles
Accounting equation
Assets = Liabilities + Owners’ Equity
Accounting period
The time to which accounting reports are related. The time is usually annual, quarterly, or monthly
Accounting policies
The accounting principles and practices adopted by a company to report its financial results
Accounting process
The procedures used for analyzing, recording, classifying, and summarizing the information to be presented in accounting reports
Accounts payable (payables)
Obligations owed to trade creditors and suppliers as incurred in the normal course of business; also called trade credit
Accounts payable days
A translation of accounts payable into the days of average purchases outstanding at a point in time; used as an indicator of the effectiveness with which trade credit is employed
Accounts receivable (receivables)
Obligations owed by customers and other parties as incurred in the normal course of business
Accounts receivable aging
A method of reviewing for uncollectible trade receivables by which an estimate of the bad debts expense is determined. The receivable balances are classified into age categories and then an estimate of noncollection is applied
Accounts receivable days
A measure of the credit quality of accounts receivable, which expresses outstanding receivables as days’ sales outstanding in terms of average daily sales; can be compared with the credit terms under which sales were made
Accrual basis
The accrual basis of accounting dictates: revenue is recognized when realized (realization concept) and expenses are recognized when incurred (matching concept)
Accruals
Recognition of revenues or expenses when earned or incurred, without regard to the actual timing of the cash transactions; used in the accrual method of accounting
Accrued expenses
Expenses incurred but not recognized in the accounts
Accrued liabilities
A liability resulting from the recognition of an expense before the payment of cash
Accumulated depreciation
The total of past periodic depreciation charges applicable to depreciable assets carried on a company’s balance sheet, shown as a deduction from gross property, plant, and equipment
Acquisition
A business combination in which one corporation acquires control over the operations of another entity
Activity ratios (asset utilization or operating efficiency ratios)
Ratios that measure how efficiently a company performs day - to - day tasks, such as the collection of receivables and management of inventory
Administrative expense
Result from the general administration of the company’s operation
Allowance method
A method of estimating bad debts on the basis of either the net credit sales of the period or the accounts receivable at the end of the period
Amortization
The process of allocating the cost of intangible long - term assets having a finite useful life to accounting periods; the allocation of the amount of a bond premium or discount to the periods remaining until bond maturity
Appreciation
An increase in the value of an asset
Asset class
An asset class is a grouping of similar types of investments that behave similarly in the marketplace and are subject to the same laws and regulations. The three main asset classes are: equities, or stocks; fixed income, or bonds cash equivalents, or money market instruments
Assets
Resources controlled by an enterprise as a result of past events and from which future economic benefits to the enterprise are expected to flow
Assets
Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events
Average cost method (inventory)
Averaging methods lump the costs of inventory to determine an average
Bad debt
An account or note receivable that proves to be entirely or partially uncollectible
Balance - sheet - based accruals ratio
The difference between net operating assets at the end and the beginning of the period compared to the average net operating assets over the period
Balance - sheet - based aggregate accruals
The difference between net operating assets at the end and the beginning of the period
Balance sheet (statement of financial position or statement of financial condition)
The financial statement that presents an entity ’ s current financial position by disclosing resources the entity controls (its assets) and the claims on those resources (its liabilities and equity claims), as of a particular point in time (the date of the balance sheet)
Balance sheet ratios
Financial ratios involving balance sheet items only
Basic earnings per share (EPS)
Net earnings available to common shareholders (i.e., net income minus preferred dividends) divided by the weighted average number of common shares outstanding
Benchmark
In the content of outcomes and performance discussion, the term refers to desired program results. It may include a target or standard for the program to achieve. It is also used to denote best practices
Book value
The original cost of an asset less any accumulated depreciation (depletion or amortization) taken to date
Book value per share
The dollar amount of the net assets of a company per share of common stock
Budget
: A quantitative plan of activities and programs expressed in terms of assets, liabilities, revenues, and expenses
Business entity
The viewpoint that the business (or entity) for which the financial statements are prepared is separate and distinct from the owners of the entity
Capital expenditures
Costs that increase the future economic benefits of an asset above those originally expected
Capital lease
Long-term lease in which the risk of ownership lies with the lessee and whose terms resemble a purchase or sale; recorded as an asset with a corresponding liability at the present value of the lease payments
Capitalization
an accounting rule used primarily by capital-intensive companies, such as manufacturing or construction, where depreciation can be a large portion of total expenses
Carrying amount (book value)
The amount at which an asset or liability is valued according to accounting principles
Cash
In accounting contexts, cash on hand (e.g., petty cash and cash not yet deposited to the bank) and demand deposits held in banks and similar accounts that can be used in payment of obligations
Cash conversion cycle (net operating cycle)
A financial metric that measures the length of time required for a company to convert cash invested in its operations to cash received as a result of its operations; equal to days of inventory on hand plus days of sales outstanding minus number of days of payables
Cash equivalents
Very liquid short - term investments, usually maturing in 90 days or less
Cash flow from operations (cash flow from operating activities or operating cash flow)
The net amount of cash provided from operating activities
Cash flow statement (statement of cash fl ows)
A financial statement that reconciles beginning - of - period and end - of - period balance sheet values of cash; consists of three parts: cash flows from operating activities, cash fl ows from investing activities, and cash fl ows from financing activities
Cash flows from financing activities
Cash flows relating to liability and owners’ equity accounts
Cash flows from investing activities
Cash flows relating to lending money and to acquiring and selling investments and productive long-term assets
Cash flows from operating activities
Generally, the cash effects of transactions and other events that determine net income
Cash ratio
A liquidity ratio calculated as (cash plus short - term marketable investments) divided by current liabilities
Classified balance sheet
A balance sheet organized so as to group together the various assets and liabilities into subcategories (e.g., current and noncurrent)
Collateral
Security for loans or other forms of indebtedness
Common - size analysis
A tool used in financial statement analysis that involves expressing financial data in relation to a single financial statement item or base; an example is an income statement in which all items are expressed as a percent of revenue
Common-size analysis (horizontal)
Common-size analysis expresses comparisons in percentages. Horizontal analysis indicates proportionate change over a period of time
Common-size analysis (vertical)
Common-size analysis expresses comparisons in percentages. Vertical analysis indicates the proportionate expression of each item in a given period to a base figure selected from that same period
Comparability
For accounting information, the quality that allows a user to analyze two or more companies and look for similarities and differences
Comprehensive income
The change in equity of a business enterprise during a period from nonowner sources; includes all changes in equity during a period except those resulting from investments by owners and distributions to owners; comprehensive income equals net income plus other comprehensive income
Consolidation
The combining of the results of operations of subsidiaries with the parent company to present financial statements as if they were a single economic unit. The asset, liabilities, revenues and expenses of the subsidiaries are combined with those of the parent company, eliminating intercompany transactions
Controlling interest
An investment where the investor exerts control over the investee, typically byhaving a greater than 50 percent ownership in the investee
Cost of goods sold
For a given period, equal to beginning inventory minus ending inventory plus the cost of goods acquired or produced during the period
Cost principle
The accounting principle that records historical cost as the appropriate basis of initial accounting recognition of all acquisitions, liabilities, and owners’ equity
Covenants
Conditions placed in a loan or credit agreement by the lender to protect its position as a creditor of the borrowing
Credit agreement
A contractual arrangement between a lender and a borrower which sets the terms and conditions for borrowing
Credit analysis
The evaluation of credit risk; the evaluation of the creditworthiness of an borrower or counterparty
Credit ratings
Formal credit risk evaluations by credit rating agencies of a company’s ability to repay principal and interest on its debt obligations
Credit risk
Uncertainty that the party on the other side of an agreement will abide by the terms of the agreement
Creditor
A party who lends money to a company
Current assets
Assets that are expected to be consumed or converted into cash in the near future, typically one year or less
Current liabilities
Those liabilities that are expected to be settled in the near future, typically one year or less
Current ratio
A liquidity ratio calculated as current assets divided by current liabilities
Current taxes payable
Tax expenses that have been recognized and recorded on a company’s income statement but which have not yet been paid
Days of sales outstanding (DSO)
An activity ratio equal to the number of days in period divided by receivables turnover
Debt
Considered to be funds a company has borrowed from a creditor
Debt - to - assets ratio
A solvency ratio calculated as total debt divided by total assets
Debt - to - capital ratio
A solvency ratio calculated as total debt divided by total debt plus total shareholders’ equity
Debt - to - equity ratio
A solvency ratio calculated as total debt divided by total shareholders’ equity
Debt covenants
Agreements between the company as borrower and its creditors
Decentralization
The freedom for managers at lower levels of the organization to make decisions
Default
A failure of a debtor to meet principal or interest payment on a debt at the due date
Deferral
The postponement of the recognition of an expense already paid or of a revenue already received
Deferred expense
An asset resulting from the payment of cash before the incurrence of expense
Deferred revenue
A liability resulting from the receipt of cash before the recognition of revenue
Deferred tax assets
A balance sheet asset that arises when an excess amount is paid for income taxesrelative to accounting profit. The taxable income is higher than accounting profit and income tax payable exceeds tax expense. The company expects to recover the difference during the course of future operations when tax expense exceeds income tax payable
Deferred tax liabilities
A balance sheet liability that arises when a deficit amount is paid for income taxes relative to accounting profit. The taxable income is less than the accounting profit and income tax payable is less than tax expense. The company expects to eliminate the liability over the course of future operations when income tax payable exceeds tax expense
Depreciation
The process of systematically allocating the cost of long - lived (tangible) assets to the periods during which the assets are expected to provide economic benefits
Depreciation expense
The process of allocating the cost of buildings, machinery, and equipment over the periods benefitted
Diluted EPS
The EPS that would result if all dilutive securities were converted into common shares
Diluted shares
The number of shares that would be outstanding if all potentially dilutive claims on common shares (e.g., convertible debt, convertible preferred stock, and employee stock options) were exercised
Direct method
For preparing the operating activities section of the statement of cash flows, the approach in which cash receipts and cash payments are reported
Discontinued operations
The disposal of a major segment of a business
Discount rate
The interest rate used to compute the present value
Discounted Cash Flow (DCF)
Measures all expected future cash inflows and outflows as if they occurred at a single point in time
Dividends
A percentage of outstanding stock issued as new shares to existing shareholders
Double - entry accounting
The accounting system of recording transactions in which every recorded transaction affects at least two accounts so as to keep the basic accounting equation (assets equal liabilities plus owners’ equity) in balance
DuPont analysis
An approach to decomposing return on investment (e.g., return on equity) as the product of other financial ratios
Earnings
A term used interchangeably with income and profit
Earnings per share
Earnings per common share of the corporation; (net income minus preferred dividends) divided by the weighted average number of common shares outstanding
Equipment
Assets used in the production of goods or in providing services
Equity
Assets minus liabilities; the residual interest in the assets after subtracting the liabilities
Exchange rate
The rate at which one unit of currency may be purchased by another unit of currency
Expenses
Outfl ows of economic resources or increases in liabilities that result in decreases in equity (other than decreases because of distributions to owners); reductions in net assets associated with the creation of revenues
Extraordinary items
Material events and transactions distinguished by their unusual nature and infrequent occurrence
FIFO method
The first in, first out, method of accounting for inventory, which matches sales against the costs of items of inventory in the order in which they were placed in inventory
Fair market value
The market price of an asset or liability that trades regularly
Fair value
The amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm ’ s - length transaction; the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
Financial covenants
The frequently ratios that the borrower is required to stay above or below (a 2:1 debt-to-equity ratio or interest coverage ratio, for example), but there are usually also restrictions on debt levels and minimum working capital requirements
Financial leverage
The extent to which a company can effect, through the use of debt, a proportional change in the return on common equity that is greater than a given proportional change in operating income; also, short for the financial leverage ratio
Financial leverage ratio
A measure of financial leverage calculated as average total assets divided by average total equity
Financial model
A mathematical model describing the interrelationships among various financial variables. Typically financial models are broken down into inputs, processing, and outputs
Financial statement (report) analysis
The process of reviewing, analyzing, and interpreting the basic financial reports
Financing activities
Activities concerned with the raising and repayment of funds in the form of debt and equity
Financing activities
Activities related to obtaining or repaying capital to be used in the business (e.g., equity and long - term debt)
First-in, first-out (FIFO) (inventory):
The flow pattern assumes that the first unit purchased is the first sold
Fixed asset turnover
An activity ratio calculated as total revenue divided by average net fixed assets
Fixed assets
Tangible, long-lived assets, primarily property, plant, and equipment. They are expected to provide service benefit for more than one year
Fixed charge coverage
A solvency ratio measuring the number of times interest and lease payments are covered by operating income, calculated as (EBIT plus lease payments) divided by (interest payments plus lease payments)
Fixed cost
Cost that remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume
Fixed costs
Costs that stay the same within some range of activity
Free cash flow
The excess of operating cash fl ow over capital expenditures
General partnership
An association in which each partner has unlimited liability
Goodwill
An intangible asset that represents the excess of the purchase price of an acquired company over the value of the net assets acquired
Gross profit (gross margin)
Sales minus the cost of sales (i.e., the cost of goods sold for a manufacturing company)
Gross profit margin
A profitability ratio calculated as gross profit divided by revenue
Hedge
A process of buying or selling commodities, forward contracts, or options for the explicit purpose of reducing or eliminating foreign exchange risk
Historical cost
In reference to assets, the amount paid to purchase an asset, including any costs of acquisition and/or preparation; with reference to liabilities, the amount of proceeds received in exchange in issuing the liability
Horizontal analysis
Common - size analysis that involves comparing a specific financial statement with that statement in prior or future time periods; also, cross - sectional analysis of one company with another
Income
Increases in economic benefits in the form of infl ows or enhancements of assets, or decreases of liabilities that result in an increase in equity (other than increases resulting from contributions by owners)
Income statement (statement of operations or profit and loss statement)
A financial statement that provides information about a company profitability over a stated period of time
Income tax paid
The actual amount paid for income taxes in the period; not a provision, but the actual cash outflow
Income tax payable
The income tax owed by the company on the basis of taxable income
Indirect format (indirect method)
With reference to cash fl ow statements, a format for the presentation of the statement which, in the operating cash fl ow section, begins with net income, then shows additions and subtractions to arrive at operating cash flow
Intangible assets
Assets lacking physical substance, such as patents and trademarks
Interest coverage ratio
A solvency ratio calculated as EBIT divided by interest payments
Inventory
The unsold units of product on hand
Inventory turnover
An activity ratio calculated as cost of goods sold divided by average inventory
Investing activities
Activities which are associated with the acquisition and disposal of property, plant, and equipment; intangible assets; other long - term assets; and both long - term and short - term investments in the equity and debt (bonds and loans) issued by other companies
Joint venture
An entity (partnership, corporation, or other legal form) where control is shared by two or more entities called venturers
LIFO method
The last in, first out, method of accounting for inventory, which matches sales against the costs of items of inventory in the reverse order the items were placed in inventory (i.e., inventory produced or acquired last are assumed to be sold first)
Liabilities
Present obligations of an enterprise arising from past events, the settlement of which is expected to result in an outfl ow of resources embodying economic benefits; creditors ’ claims on the resources of a company
Liquidity
With reference to a firm financial condition, the ability to meet short - term obligations
Liquidity ratios
Financial ratios measuring the company ’ s ability to meet its short - term obligations
Long - lived assets (long - term assets)
Assets that are expected to provide economic benefits over a future period of time, typically greater than one year
Long - term liability
An obligation that is expected to be settled, with the outfl ow of resources embodying economic benefits, over a future period generally greater than one year
Mark - to - market
The revaluation of a financial asset or liability to its current market value or fair value
Minority active investments
Investments in which investors exert significant influence, but not control, over the investee. Typically, the investor has 20 percent to 50 percent ownership in the investee
Minority interest
The portion of consolidated subsidiaries ’ net assets not owned by the parent
Minority interests (noncontrolling interests)
The proportion of the ownership of a subsidiary not held by the parent (controlling) company
Monetary assets and liabilities
Assets and liabilities with value equal to the amount of currency contracted for, a fixed amount of currency. Examples are cash, accounts receivable, mortgages receivable, accounts payable, bonds payable, and mortgages payable. Inventory is not a monetary asset. Most liabilities are monetary
Net book value
The remaining (undepreciated) balance of an asset ’ s purchase cost. For liabilities, the face value of a bond minus any unamortized discount, or plus any unamortized premium
Net income (loss)
The difference between revenue and expenses; what remains after subtracting all expenses (including depreciation, interest, and taxes) from revenue
Net operating assets
The difference between operating assets (total assets less cash) and operating liabilities (total liabilities less total debt)
Net profit margin (profit margin or return on sales)
An indicator of profitability, calculated as net income divided by revenue
Net revenue
Revenue after adjustments (e.g., for estimated returns or for amounts unlikely to be collected)
Noncurrent assets
Assets that are expected to benefit the company over an extended period of time (usually more than one year)
Nonmonetary assets and liabilities
Assets and liabilities that are not monetary assets and liabilities. Nonmonetary assets include inventory, fixed assets, and intangibles, and nonmonetary liabilities include deferred revenue
Number of days of inventory
An activity ratio equal to the number of days in a period divided by the inventory ratio for the period; an indication of the number of days a company ties up funds in inventory
Number of days of payables
An activity ratio equal to the number of days in a period divided by the payables turnover ratio for the period; an estimate of the average number of days it takes a company to pay its suppliers
Operating activities
Activities that are part of the day - to - day business functioning of an entity, such as selling inventory and providing services
Operating leverage
The use of fixed costs in operations
Operating profit (operating income)
A company’s profits on its usual business activities before deducting taxes
Operating profit margin (operating margin)
A profitability ratio calculated as operating income divided by revenue
Operating return on assets (operating ROA)
A profitability ratio calculated as operating income divided by average total assets
Ordinary shares (common stock or common shares)
Equity shares that are subordinate to all other types of equity (e.g., preferred equity)
Other comprehensive income
Items of comprehensive income that are not reported on the income statement; comprehensive income minus net income
Other receivables
Amounts owed to the company from parties other than customers
Owners ’equity
The excess of assets over liabilities; the residual interest of shareholders in the assets of an entity after deducting the entity ’ s liabilities
Payables turnover
An activity ratio calculated as purchases divided by average trade payables
Prepaid expense
A normal operating expense that has been paid in advance of when it is due
Present value
The present discounted value of future cash fl ows: for assets, the present discounted value of the future net cash infl ows that the asset is expected to generate in the normal course of business; for liabilities, the present discounted value of the future net cash outfl ows that are expected to be required to settle the liabilities in the normal course of business
Pretax margin
A profitability ratio calculated as earnings before taxes divided by revenue
Price to book value
A valuation ratio calculated as price per share divided by book value per share
Price to cash flow
A valuation ratio calculated as price per share divided by cash fl ow per share
Price to sales
A valuation ratio calculated as price per share divided by sales per share
Profitability ratios
Ratios that measure a company ’ s ability to generate profitable sales from its resources (assets)
Quick ratio
A liquidity ratio calculated as (cash plus short - term marketable investments plus receivables) divided by current liabilities
Receivables turnover
An activity ratio equal to revenue divided by average receivables
Return on assets (ROA)
A profitability ratio calculated as net income divided by average total assets
Return on common equity (ROCE)
A profitability ratio calculated as (net income minus preferred dividends) divided by average common equity; equal to the return on equity ratio when no preferred equity is outstanding
Return on equity (ROE)
A profitability ratio calculated as net income divided by average shareholders’ equity
Return on total capital
A profitability ratio calculated as EBIT divided by the sum of short - and long - term debt and equity
Revenue
The amount charged for the delivery of goods or services in the ordinary activities of a business over a stated period; the infl ows of economic resources to a company over a stated period
Sales
Generally, a synonym for revenue; “ sales ” is generally understood to refer to the sale of goods, whereas “ revenue ” is understood to include the sale of goods or services
Scenario analysis
Analysis that shows the changes in key financial quantities that result from given (economic) events, such as the loss of customers, the loss of a supply source, or a catastrophic event
Sensitivity analysis
Analysis that shows the range of possible outcomes as specific assumptions are changed
Solvency
Ability of a company to fulfill its long - term obligations
Solvency ratios
Ratios that measure a company ’ s ability to meet its long - term obligations
Statement of cash flows (cash fl ow statement)
A financial statement that reconciles beginning - of - period and end - of - period balance sheet values of cash; provides information about an entity ’ s cash inflows and cash outfl ows as they pertain to operating, investing, and financing activities
Statement of changes in shareholders ’equity (statement of owners ’equity)
A financial statement that reconciles the beginning - of - period and end - of - period balance sheet values of shareholders ’ equity; provides information about all factors affecting shareholders ’ equity
Statement of retained earnings
A financial statement that reconciles beginning - of - period and end - of - period balance sheet values of retained income; shows the linkage between the balance sheet and income statement
Straight - line method
A depreciation method that allocates evenly the cost of a long - lived asset less its estimated residual value over the estimated useful life of the asset
Tangible assets
Long - term assets with physical substance that are used in company operations, such as land (property), plant, and equipment
Tax expense
An aggregate of an entity ’ s income tax payable (or recoverable in the case of a tax benefit) and any changes in deferred tax assets and liabilities. It is essentially the income tax payable or recoverable if these had been determined based on accounting profit rather than taxable income
Top - down analysis
With reference to investment selection processes, an approach that starts with macro selection (i.e., identifying attractive geographic segments and/or industry segments) and then addresses selection of the most attractive investments within those segments
Total asset turnover
An activity ratio calculated as revenue divided by average total assets
Trade receivables (commercial receivables or accounts receivable)
Amounts customers owe the company for products that have been sold as well as amounts that may be due from suppliers (such as for returns of merchandise)
Units - of - production method
A depreciation method that allocates the cost of a long - lived asset based on actual usage during the period
Valuation allowance
A reserve created against deferred tax assets, based on the likelihood of realizing the deferred tax assets in future accounting periods
Valuation ratios
Ratios that measure the quantity of an asset or fl ow (e.g., earnings) in relation to the price associated with a specified claim (e.g., a share or ownership of the enterprise)
Variable costs
Costs that rise proportionally with revenue
Vertical analysis
Common - size analysis using only one reporting period or one base financial statement; for example, an income statement in which all items are stated as percentages of sales
Weighted average cost method
An inventory accounting method that averages the total cost of available inventory items over the total units available for sale
Working capital
The excess of current assets over current liabilities
Working capital turnover
An activity ratio calculated as revenue divided by average working capital