Glossary of Common Financial Terms in the UK

The following financial terms definitions are for the most commonly used in the UK.  They are to be used in the modern context of the UK Company Balance Sheet, Profit and Loss Account, and Cashflow Statement conventions.

Certain financial terms can often mean different things to different companies depending on their own particular accounting policies and house styles. Don’t be intimidated by financial terminology or confusing figures and methodology. Always ask for clarification, and you will find that most financial managers and accountants are generally very happy to explain themselves with clarity.

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Acid Test – A clear measure of a company’s ability to pay its short-term debts.  Also referred to as the Quick Ratio.

Assets - Anything physical items owned by the company that hold a monetary value; eg, ‘fixed’ assets like buildings, plant and machinery, vehicles (these are not assets if rented and or leased). Assets can potentially include intangibles like trademarks and brand names. There are also ‘current’ assets such as stock, debtors and cash.

Asset Turnover - Measure of operational efficiency – shows how much revenue is produced per of assets available to the business. (sales revenue/total assets less current liabilities)

Balance Sheet -  The Balance Sheet is one of the three essential component measuring reports for the performance and health of a company alongside the Profit and Loss Account (P+L) and the Cashflow Statement. The Balance Sheet is a ‘snapshot’ in time of who owns what within the company, and which assets and debts represent the value of the company. The Balance Sheet is where to look for information about short-term and long-term debts, gearing (the ratio of debt to equity), reserves, stock values (materials and finished goods), capital assets, cash on-hand, along with the value of shareholders’ funds.

The term Balance Sheet is derived from the simple purpose of detailing where the money came from, and where it is now. The Balance Sheet equation is fundamentally: (where the money came from) Capital + Liabilities = Assets (where the money is now). Hence the term ‘double entry’ – for every change on one side of the Balance Sheet, so there must be a corresponding change on the other side – it must always balance. The Balance Sheet does not show how much profit the company is making (the P&L does this), although pervious years’ retained profits will add to the company’s reserves, which are shown in the balance sheet.

Budget – In a financial planning context the word ‘budget’ means an amount of money that has been allotted to be spent on a particular activity or resource. Budgets apply to shorter and longer periods. A large organisational plan contains the budgets for all of its different departments and costs held by each of them.

The verb to ‘budget’ means to calculate and set a budget, although in a looser context it also means to be careful with money and seek out reductions by setting a lower-budgeted level of expenditure.

In the UK the Government’s annual plan is called ‘The Budget’.

(also see Forecast)

Capital Employ – Capital Employ is value of all resources available to the company, typically comprising share capital, retained profits and reserves, long-term loans and deferred taxation. Viewed from the other side of the balance sheet, Capital Employ amounts to the total long-term funds invested in or lent to the business and used by it in carrying out its operations.

Cashflow – Cashflow is the movement of money in and out of a business. The cash may be generated from day-to-day direct trading and other non-trading or indirect effects, such as capital expenditure, tax and dividend payments.

Cashflow Statement – One of the three essential reporting and measurement systems for any company. The Cashflow Statement provides a third perspective alongside the P+L account and Balance Sheet. The Cashflow Statement shows the movement and availability of cash through and to the business over a given period, certainly for a trading year, and often also monthly and cumulatively.

The availability of cash in a company that is necessary to meet payments to suppliers, staff and other creditors is essential for any business to survive, and so the reliable forecasting and reporting of cash movement and availability is crucial.

Cost of Debt Ratio –  The term refers to the interest expense over a given period as a percentage of the average outstanding debt over the same period, ie., cost of interest divided by average outstanding debt.

Cost of Goods Sold (COGS) – The directly attributable costs of products or services sold, ie; materials, labour and direct production costs. Sales less COGS = gross profit. COGS equates to the same as cost of sales (COS).

Cost of Sales (COS) – COS is arrived at via the formula: (opening stock + stock purchased – closing stock)

In all accounts, particularly the P+L (trading account) it’s important that costs are attributed to relevant revenues, or the report will be rendered distorted and potentially meaningless. The formula is the most logical way of calculating the value at cost of all goods sold, irrespective of when the stock was purchased. The value of the stock attributable to the sales in the period (COS) is the total of what we started with in stock (opening stock), and what we purchased (stock purchases), minus what stock we have left over at the end of the period (closing stock).

Current Assets – Cash and any assets that is expected to be converted into cash within twelve months of the balance sheet date.

Current Ratio - The relationship between Current Assets and Liabilities, indicating the liquidity of a business, ie; its ability to meet its short-term obligations. Also referred to as the Liquidity Ratio.

Current Liabilities – Money owed by the business that is generally due for payment within 12 months of balance sheet date. Examples: creditors, bank overdraft, taxation.

Depreciation - The apportionment of cost to a (usually) large capital item over an agreed period. It is based on said items’ life expectancy or obsolescence, eg; a piece of equipment costing £10k having a life of five years might be depreciated over five years at a cost of £2k per year.

Dividend – A dividend is a payment made per share, to a company’s shareholders by another company, based on the profits of the year.  A company can choose to pay a dividend from reserves following a loss-making year, and conversely a company can choose to pay no dividend after a profit-making year, depending on what is believed to be in the best interests of the company. Along with the increase in the value of a stock or share, the annual dividend provides the shareholder with a return on the shareholding investment.

Earning Before… -  There are several ‘Earnings Before..’ ratios and acronyms: EBT = Earnings Before Taxes; EBIT = Earnings Before Interest and Taxes; EBIAT = Earnings Before Interest after Taxes; EBITD = Earnings Before Interest, Taxes and Depreciation; and EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization.

Earnings = operating and non-operating profits (eg. interest, dividends received from other investments). Depreciation is the non-cash charge to the balance sheet which is made in writing off an asset over a period. Amortisation is the payment of a loan in installments.

Fixed Assets -  These are assets held for use by the business rather than for sale or conversion into cash, eg. fixtures and fittings, equipment, buildings etc.

Fixed Cost - A cost which does not vary with changing sales or production volumes, eg. building lease costs, permanent staff wages, rates, depreciation of capital items.

Free On Board (FOB)The FOB (Free On Board)  is an import/export term relating to the point at which responsibility for goods passes from seller (exporter) to buyer (importer). It’s in this listing because it’s commonly misunderstood and also has potentially significant financial implications. FOB meant originally (and depending on the context stills generally means) that the seller is liable for the goods and is responsible for all costs of transport, insurance, etc., until and including the goods being loaded at the (nominated FOB) port.

The FOB expression originates particularly from the meaning that the buyer is free of liability and costs of transport up to the point that the goods are loaded on board the ship. In modern times FOB also applies to freight for export by aircraft from airports. It can also mean ‘Freight On Board’. which is technically incorrect.

Forecast -  A forecast in certain contexts means the same as a budget – a prediction of performance  that includes costs and/or revenues, or other data such as headcount, percentage based performance, etc. In simple terms: budget = plan or a cost element within a plan; forecast = updated budget or plan.

Gearing - Gearing refers to the ratio of debt to equity, usually the relationship between long-term borrowings and shareholders’ funds.

Goodwill - Any surplus money paid to acquire a company that exceeds its net tangible assets value.

Gross Profit -  Gross Profit = Sales – cost of goods or services sold.

Also referred to as gross profit margingross profit and simply ‘margin‘. See also ‘net profit‘.

Initial Public Offering (IPO) -  An Initial Public Offering (IPO) is the Stock Exchange and corporate acronym for the first sale of privately owned equity in a company via the issue of stocks or shares to the public and other investing institutions.

IPOs typically involve small, young companies raising capital to finance growth. For investors IPO‘s can be risky as it is difficult to predict the value of the stock (shares) when they open for trading. An IPO is effectively short for when a new company  ‘goes public’

Letters of Credit - A Letter of Credit is a guarantee from the issuing bank’s to the seller that if compliant documents are presented by the seller to the buyer’s bank, then the buyer’s bank will pay the seller the amount due. The ‘compliance’ of the seller’s documentation covers not only the goods or services supplied, but also the timescales involved, method for, format of and place at which the documents are presented. It is common for exporters to experience delays in obtaining payment against letters of credit because they have either failed to understand the terms within the letter of credit, failed to meet the terms, or both. It is important therefore for sellers to understand all aspects of letters of credit and to ensure letters of credit are properly drafted, checked, approved and their conditions met. It is also important for sellers to use appropriate professional services to validate the authenticity of any unknown bank issuing a letter of credit.

Letters of Guarantee –  There are many types of letters of guarantee. These types of letters of guarantee are concerned with providing safeguards to buyers that suppliers will meet their obligations or vice-versa, and are issued by the supplier’s or customer’s bank.

Liabilities -  A liability is the term for the debts a business may owe. Liabilities can be long-term loans of the type used to finance the business and short-term debts or money owing as a result of trading activities to date . Long term liabilities, along with Share Capital and Reserves make up one side of the balance sheet equation showing where the money came from. The other side of the balance sheet will show Current Liabilities along with various Assets, showing where the money is now.

Liquidity Ratio - This indicates the company’s ability to pay its short term debts, by measuring the relationship between current assets against the short-term debt value.  Also referred to as the Current Ratio.

Net Assets (also called Total Net Assets) – Net Assets are the sum of total assets (both fixed and current) less current liabilities and long-term liabilities that have not been capitalised (eg. short-term loans).

Net Current AssetsCurrent Assets minus Current Liabilities.

Net Present Value (NPV) – NPV is a significant measurement in business investment decisions. NPV is  a measurement of all future cashflow (revenues minus costs, also referred to as net benefits) that will be derived from a particular investment (whether in the form of a project, a new product line, a proposition, or an entire business), minus the cost of the investment.

Net Profit - Net Profit can have different meanings. Net strictly means ‘after all deductions have been considered‘ as opposed to just certain deductions used to arrive at a gross profit or margin. Net profit refers to the profit made after deduction of all operating expenses, notably after deduction of fixed costs or fixed overheads. This contrasts with the term ‘Gross Profit’ which normally refers to the difference between sales and direct cost of product or service sold (also referred to as gross margin and  gross profit margin) and certainly before the deduction of operating costs or overheads. Net Profit normally refers to the profit figure before deduction of corporation tax, in which case the term is often extended to ‘Net Profit Before Tax’ or NPBT.

Opening/Closing Stock –  See Cost of Sales.

Overhead –  An Overhead is an expense that cannot be attributed to any one single part of the company’s activities.

P/E Ratio (Price per Earnings) – The P/E Ratio is an important indicator as to how the investing market views the health, performance, prospects and investment risk of a public company listed on a stock exchange (a listed company). Here is how to calculate the P/E ratio in a few simple steps:

1. Establish total profit after tax and interest for the past year.

2. Divide this by the number of shares issued.

3. This gives you the earnings per share.

4. Divide the price of the stock or share by the earnings per share.

5. This gives the Price/Earnings or P/E ratio.

Profit and Loss Account (P+L) – The P+L is one of the three principal business reporting and measuring tools (along with the balance sheet and cashflow statement). The P+L is essentially a trading account for a period, usually a year, but also can be monthly and cumulative. It shows profit performance, which often has little to do with cash, stocks and assets (which must be viewed from a separate perspective using balance sheet and cashflow statement). The P+L  shows sales revenues, cost of sales/cost of goods sold, generally a gross profit margin (sometimes called ‘contribution’), fixed overheads and or operating expenses, and then a profit before tax figure (PBT). A fully detailed P+L can be highly complex, but only because of all the weird and wonderful policies and conventions that the company employs. The P+L shows how well the company has performed in its trading activities.

Quick Ratio -  A Quick Ratio is the as the Acid Test. The relationship between current assets readily convertible into cash (ie, current assets less stock) and current liabilities. A sterner test of liquidity.

Reserves -  Reserves are the accumulated and retained difference between profits and losses year on year since the company’s formation.

Restricted Funds –  These are funds used by an organisation that are restricted or earmarked by a donor for a specific purpose, which can be extremely specific or quite broad, eg. endowment or pensions investment; research (in the case of donations to a charity or research organisation); or a particular project with agreed terms of reference and outputs such as to meet the criteria or terms of the donation or award or grant. The source of restricted funds can be from government, foundations and trusts, grant-awarding bodies, philanthropic organisations, private donations, bequests from wills, etc. The practical implication is that restricted funds are ring-fenced and must not be used for any other than their designated purpose.

Return On Capital Employed (ROCE) – ROCE is a fundamental financial performance measure. A percentage figure representing profit before interest against the money that is invested in the business.

Return On Investment (ROI) -  ROI is a fundamental financial and business performance measure. Many business managers and owners use the term in a general sense as a means of assessing the merit of an investment or business decision. ‘Return’ generally means profit before tax.  Most CEO’s and business owners regard ROI as the ultimate measure of any business or any business proposition, after all it’s what most business is aimed at producing – maximum return on investment, otherise you might as well put your money in a bank savings account. Strictly speaking ROI is defined as: Profits derived as a proportion of and directly attributable to cost or ‘book value’ of an asset, liability or activity, net of depreciation.

Share Capital -  Share Capital is the balance sheet nominal value paid into the company by shareholders at the time(s) shares were issued.

Shareholders’ Funds –  A measure of the shareholders’ total interest in the company represented by the total share capital plus reserves.

Telegraphic Transfer (T/T) -  A T/T is an international banking payment method: a telegraphic transfer payment, commonly used/required for import/export trade, between a bank and an overseas party enabling transfer of local or foreign currency by telegraph, cable or telex. Also called a cable transfer. The terminology dates from times when such communications were literally ‘wired’ – before wireless communications technology were invented.

Variable Cost - A cost which varies with sales or operational volumes, eg. materials, fuel, commission payments.

Working Capital - Current assets less current liabilities, representing the required investment, continually circulating, to finance stock, debtors, and work in progress.

 

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