Understanding Business Accounting For Dummies, 2nd Edition (131 page)

Part VI

In this part . . .

W
e're not finished yet! We couldn't say goodbye without adding in a couple of helpful appendixes filled to the brim with extra information.

The world of accounting is a jargon-filled place, so we've included a glossary in Appendix A that enables you to understand the terms you're most likely to come across and to be clued-up when talking the talk.

Appendix B is another handy list, giving you the lowdown on different accounting software packages - useful when deciding which package is the one for your business.

Appendix A
:
Glossary: Slashing through the Accounting Jargon Jungle

Y
ou can keep up with the latest financial jargon on the Free Dictionary Web site at
http://financial-dictionary.thefreedictionary.com
.

accounting:
The methods and procedures for analysing, recording, accumulating, and storing financial information about the activities of an entity, and preparing summary reports of these activities internally for managers and externally for those entitled to receive financial reports about the entity.

accounting equation:
Assets = Liabilities + Owners' Equity. This basic equation is the foundation for
double-entry accounting
and reflects the balance between a business's assets and the sources of capital that is invested in its assets.

Accounting Standards Board (ASB):
The highest authoritative, private-sector, standard-setting body of the accounting profession in the United Kingdom. The ASB issues pronouncements that establish
generally accepted accounting principles (GAAP).

accrual-basis accounting:
From the profit accounting point of view this refers to recording revenue at the time sales are made (rather than when cash is actually received from customers), and recording expenses to match with sales revenue or in the period benefited (rather than when the costs are paid). From the financial condition point of view this refers to recording several assets, such as receivables from customers, cost of stock (products not yet sold), and cost of long-term assets (fixed assets); - and recording several liabilities in addition to debt (borrowed money), such as payables to vendors and payables for unpaid expenses.

accrued expenses payable:
One main type of short-term liabilities of a business that arise from the gradual build-up of unpaid expenses, such as holiday pay earned by employees or profit-based bonus plans that aren't paid until the following period.
Caution:
The specific titles of this liability vary from business to business; you may see accrued liabilities, accrued expenses, or some other similar account name.

accumulated depreciation:
The total cumulative amount of depreciation expense that has been recorded since the fixed assets being depreciated were acquired. In the
balance sheet
the amount in this account is deducted from the cost of fixed assets. (Thus it is sometimes referred to as a contra account.) The purpose is to report how much of the total cost has been depreciated over the years. The balance of cost less accumulated depreciation is included in the total assets of a business - which is known as the
book value
of the assets.

acid-test ratio:
See
quick ratio.

activity based costing (ABC):
The ABC approach classifies overhead costs into separate categories of support activities that are needed in manufacturing operations and in other areas of the business organisation (such as a sales territory). Cost drivers are developed for each support activity to measure the extent of usage of that support. The annual cost of each support activity is allocated to manufacturing and other areas according to how many cost driver units are used.

Alternative Investment Market (AIM):
A stock market in London for shares in small and relatively unproven businesses.

annualised rate of interest and rate of return:
The result of taking a rate of interest or a rate of return on investment for a period shorter than one year and converting it into an equivalent rate for the entire year. Suppose you earn 2 per cent interest rate every quarter (three months). Your annualised rate of interest (as if you received interest once a year at the end of the year) equals 8.24 per cent rounded - which is not simply 4 times the 2 per cent quarterly rate. (The annualised rate equals [1+0.02] raised to the fourth power minus one.) See also
compound interest
.

asset turnover ratio:
A measure of how effectively assets were used during a period, usually one year. To find the asset turnover ratio, divide annual sales revenue either by total assets or by
net operating assets
, which equals total assets less short-term, non-interest-bearing liabilities.

Association of Chartered Accountants (ACA):
The ACA designation is a widely recognised and respected badge of a professional accountant. A person must meet educational and experience requirements and pass a national uniform exam to qualify.

audit report:
A one-page statement issued by an accountancy firm, after having examined a company's accounting system, records, and supporting evidence, that gives an opinion whether the company's financial statements and footnotes are presented fairly in conformity with
generally accepted accounting principles
. Annual audits are required by limited companies of publicly-owned corporations; many privately-held businesses also have audits. The auditor must be independent of the business. An auditor expresses doubts about the financial viability of a business if it is in dire financial straits.

bad debts:
The particular expense that arises from a customer's failure to pay the amount owed to the business from a prior credit sale. When the credit sale was recorded, the accounts receivable asset account was increased. When it becomes clear that this debt owed to the business will not be collected, the asset account is written-off and the amount is charged to bad debts expense.

balance sheet:
The
financial statement
that summarises the assets, liabilities, and owners' equity of a business at an instant moment in time. Prepared at the end of every profit period, and whenever needed, the balance sheet shows a company's overall financial situation and condition.

basic earnings per share (EPS):
Equals
net income
for the year (the most recent twelve months reported, called the trailing twelve months) divided by the number of shares of a business corporation that have been issued and are owned by shareholders (called the number of shares outstanding). See also
diluted earnings per share
. Basic EPS and diluted EPS are the most important factors that drive the market value of shares issued by publicly-owned corporations.

book value of assets:
Refers to the recorded amounts of assets which are reported in a
balance sheet
- usually the term is used to emphasise that the amounts recorded in the accounts of the business may be less than the current replacement costs of some assets, such as fixed assets bought many years ago that have been depreciated.

book value of owners' equity, in total or per share:
Refers to the
balance sheet
value of owners' equity, either in total or on a per-share basis for corporations. Book value of owners' equity is not necessarily the price someone would pay for the business as a whole or per share, but it is a useful reference, or starting point for setting market price.

break-even point (sales volume):
The annual sales volume (total number of units sold) at which total
contribution margin
equals total annual
fixed expenses
- that is, the exact sales volume at which the business covers its fixed expenses and makes a zero profit, or a zero loss depending on your point of view. Sales in excess of the break-even point contribute to profit, instead of having to go towards covering fixed expenses. The break-even sales volume is a useful point of reference for analysing profit performance and the effects of
operating leverage
.

budgeting:
The process of developing and adopting a profit and financial plan with definite goals for the coming period - including forecasting expenses and revenues, assets, liabilities, and cash flows based on the plan.

burden rate:
An amount per unit that is added to the direct costs of manufacturing a product according to some method for the allocation of the total indirect fixed manufacturing costs for the period, which can be a certain percentage of direct costs or a fixed pound amount per unit of the common denominator on which the indirect costs are allocated across different products. Thus, the indirect costs are a ‘burden' on the direct costs.

business angel:
Private individuals who invest in entrepreneurial businesses with a view to making a substantial capital gain and perhaps helping with the management.

capital expenditures:
Outlays for
fixed assets
- to overhaul or replace old fixed assets, or to expand and modernise the long-lived operating resources of a business. Fixed assets have useful lives from 3 to 39 (or more) years, depending on the nature of the asset and how it's used in the operations of the business. The term ‘capital' here implies that substantial amounts of money are being invested that are major commitments for many years.

capital stock:
The certificates of ownership issued by a corporation for capital invested in the business by owners; total capital is divided into units, called shares of capital stock. Holders of shares participate in cash dividends paid from profit, vote in board member elections, and receive asset liquidation proceeds; and have several other rights as well. A business corporation must issue at least one class of share called ordinary shares, which in the US are known as
common stock
. It may also issue other classes of stock, such as
preference shares
.

cash flow(s):
In the most general and broadest sense this term refers to any kind of cash inflows and outflows during a period - monies coming in, and monies paid out.

cash flow from operating activities:
See
cash flow from profit
.

cash flow from profit:
In the
cash flow statement
this is called
cash flow from operating activities
, which equals net income for the period, adjusted for changes in certain assets and liabilities, and for depreciation expense. Some people call this
free cash flow
to emphasise that this source of cash is free from the need to borrow money, issue capital stock shares, or sell assets.
Be careful:
The term free cash flow is also used to denote cash flow from profit minus capital expenditures. (Some writers deduct cash dividends also; usage has not completely settled down.)

cash flow statement:
This financial statement of a business summarises its cash inflows and outflows during a period according to a threefold classification:
cash flow from profit
(or,
operating activities
),
investing activities
, and
financing activities
.