Understanding Business Accounting For Dummies, 2nd Edition (133 page)

financial statement:
The generic term for
balance sheet, cash flow statement, and profit and loss account
, all three of which present summary financial information about a business.

financing activities:
One of three types of
cash flows
reported in the
cash flow statement
. These are the dealings between a business and its sources of debt and equity capital - such as borrowings and repayments of debt, issuing new shares and buying some of its own shares, and paying dividends.

first-in, first-out (FIFO):
One of two widely-used accounting methods by which costs of products when they are sold are charged to cost of goods sold expense in chronological order, so the most recent acquisition costs remain in stock at the end of the period. However, the reverse order also is acceptable, which is called the
last-in, first-out (LIFO)
method.

fixed assets:
The shorthand term for the long-life (generally three years or longer) resources used by a business, which includes land, buildings, machinery, equipment, tools, and vehicles. The most common account title for these assets you see in a balance sheet is ‘property, plant, and equipment'.

fixed expenses (costs):
Those expenses or costs that remain unchanged over the short run and do not vary with changes in sales volume or sales revenue - common examples are property rental and rates, salaries of many employees, and telephone lease costs.

footnotes:
Footnotes are attached to the three primary financial statements to present detailed information that cannot be put directly in the body of the financial statements.

free cash flow:
Many people use this term to mean the amount of
cash flow from profit
- although some writers deduct capital expenditures from this number, and others deduct cash dividends as well.

gearing:
The relationship between a firm's
debt capital
and its
equity
.
The higher the proportion of debt, the more highly geared is the business. In the US, the term leverage is usually used here.

general ledger:
The complete collection of all the accounts used by a business (or other entity) to record the financial effects of its activities. More or less synonymous with
chart of accounts
.

generally accepted accounting principles (GAAP):
The authoritative standards and approved accounting methods that should be used by businesses and private not-for-profit organisations to measure and report their revenue and expenses, and to present their assets, liabilities, and owners' equity, and to report their cash flows in their financial statements.

going-concern assumption:
The accounting premise that a business will continue to operate and will not be forced to liquidate its assets.

goodwill:
Goodwill has two different meanings, so be careful. The term can refer to the product or brand name recognition and the excellent reputation of a business that provide a strong competitive advantage. Goodwill in this sense means the business has an important but invisible ‘asset' that is not reported in its balance sheet. Second, a business may purchase and pay cash for the goodwill that has been built up over the years by another business. Only purchased goodwill is reported as an asset in the balance sheet.

gross margin (profit):
Equals sales revenue less cost of goods sold for the period. On a per unit basis, gross margin equals sales price less product cost per unit. Making an adequate gross margin is the starting point for making bottom-line
net income
.

hedge fund:
A fund that uses derivatives, short selling, and arbitrage techniques, selling assets that one does not own in the expectation of buying them back at a lower price. This gives hedge fund managers a range of ways to generate growth in falling, rising, and even in relatively static markets.

hedging:
A technique used to manage commercial risk or to minimise a potential loss by using counterbalancing investment strategies.

hostile merger:
The term used where a business is acquired against the wishes of the incumbent management.

hurdle rate:
The rate of return required before an investment is considered worthwhile.

hyperinflation:
A situation where prices increase so quickly that money is virtually useless as a store of value.

imputed cost:
A hypothetical cost used as a benchmark for comparison. One example is the imputed cost of equity capital. No expense is recorded for using owners' equity capital during the year. However, in judging net income performance, the company's rate of
return on equity (ROE)
is compared with the rate of earnings that could be accrued on the capital if it were invested elsewhere. This alternative rate of return is an imputed cost. Close in meaning to the economic concept of
opportunity cost
.

income smoothing:
See
profit smoothing
.

income statement:
American term used for the profit and loss account.

income tax payable:
The tax due, but as yet unpaid, on profits earned.

incubator:
Usually both a premises and some or all of the services (legal, managerial, or technical) needed to launch a business and access seed capital.

initial public offering (IPO):
The first offer of a company's shares made to the general public.

insider trading:
Buying or selling shares based on information not in the public domain.

internal (accounting) controls:
Accounting forms, procedures, and precautions that are established primarily to prevent and minimise errors and fraud (beyond what would be required for record keeping).

investing activities:
One of three classes of
cash flows
reported in the
cash flow statement
. In large part these are the
capital expenditures
by a business during the year, which are major investments in long-term assets. A business may dispose of some of its fixed assets during the year, and proceeds from these disposals (if any) are reported in this section of the cash flow statement.

junior market:
A stock market (such as the AIM) where shares of smaller or younger companies are traded.

last-in, first-out (LIFO):
One of two widely used accounting methods by which costs of products when they are sold are charged to cost of goods sold expense in reverse chronological order, one result being that the ending stock cost value consists of the costs of the earliest goods purchased or manufactured. The opposite order is also acceptable, which is called the
first-in, first-out (FIFO)
method
.
The actual physical flow of products seldom follows a LIFO sequence. The method is justified on the grounds that the cost of goods sold expense should be the cost of replacing the products sold, and the best approximation is the most recent acquisition costs of the products.

leverage:
see
financial leverage
and
operating leverage
.

leveraged buyout:
A situation where a company is bought by another financed mainly by debt, such as bank borrowings.

LIFO liquidation gain:
A unique result of the
last-in, first-out (LIFO)
method, which happens when fewer units are replaced than sold during the period. The decrease in stock requires that the accountant go back into the old cost layers of stock for part of the cost of goods sold expense. Thus, there is a one-time windfall gain in
gross margin
, roughly equal to the difference between the historical cost and the current cost of the stock decrease. A large LIFO liquidation gain should be disclosed in a footnote to the financial statements.

limited liability company (Ltd):
Company whose shareholders have limited their liability to the amounts they subscribe to the shares they hold.

listed company:
A company whose shares are on the official list of a major stock market, such as the London Stock Exchange.

management accounting:
The branch of accounting that prepares internal financial statements and various other reports and analyses to assist managers to do their jobs.

management buy-out:
The term used when the management of a business buys out the existing shareholders, usually with the help of a venture capital firm.

margin of safety:
Equals the excess of actual sales volume over the company's
break-even point
; often expressed as a percentage. This information is used internally by managers and is not disclosed in external financial reports
.

market cap:
The total value of a business calculated by multiplying the current market price of its capital stock by the total number of shares issued by the business. This calculated amount is not money that has been invested in the business, and the amount is subject to the whims of the stock market.

net income:
American term used to describe profit.

net operating assets:
The total amount of assets used in operating a business, less its short-term non-interest-bearing liabilities. A business must raise an equal amount of capital.

net realisable value (NRV):
A special accounting test applied to stock that can result in a write-down and charge to expense for the loss in value of products held for sale. The recorded costs of products in stock are compared with their current replacement costs (market price) and with net realisable value if normal sales prices have been reduced. If either value is lower, then recorded cost is written down to this lower value.
Note:
Stock is not written up when replacement costs rise after the stock was acquired.

net worth:
Balance sheet value of owner's stake in the business. It consists both of the money put in at the start and any profits made since and left in the business.