Understanding Business Accounting For Dummies, 2nd Edition (134 page)

notes to financial statements:
Notes attached to the
balance sheet
and
income statement
which explain: (a) Significant accounting adjustments; (b) Information required by law, if not disclosed in the financial statements.

operating activities:
The profit-making activities of a business - that is, the sales and expense transactions of a business. See also
cash flow from operating activities
.

operating assets:
The several different assets, or economic resources, used in the profit-making operations of a business. Includes cash, accounts receivable from making sales on credit, stock of products awaiting sale, prepaid expenses
,
and various fixed, or long-life assets
.

operating cycle:
The repetitive sequence over a period of time of producing or acquiring stock, holding it, selling it on credit, and finally collecting the account receivable from the sale. It is a ‘cash-to-cash' circle - investing cash in stock, then selling the products on credit, and then collecting the receivable.

operating earnings (profit):
See
earnings before interest and taxes (EBIT).

operating leverage:
Once a business has reached its
break-even point
, a relatively small percentage increase in sales volume generates a much larger percentage increase in profit; this wider swing in profit is the idea of operating leverage. Making sales in excess of its break-even point does not increase total fixed expenses, so all the additional
contribution margin
from the sales goes to profit.

operating liabilities:
Short-term liabilities generated spontaneously in the profit-making operations of a business. The most common ones are
payable creditors
,
accrued expenses payable
, and
income tax payable
- none of which are interest-bearing unless a late payment penalty is paid, which is in the nature of interest.

opportunity cost:
An economic definition of cost referring to income or gain that could have been earned from the best alternative use of money, time, or talent foregone by taking a particular course of action.

ordinary shares:
Normal shares in business used to apportion ownership.

overhead costs:
Sales and administrative expenses, and manufacturing costs that are indirect, which means they cannot be naturally matched or linked with a particular product, revenue source, or organisational unit - one example is the annual property tax on the building in which all the company's activities are carried out.

owners' equity:
The ownership capital base of a business. Owners' equity derives from two sources: investment of capital in the business by the owners (for which shares are issued by a company), and profit that has been earned by the business but has not been distributed to its owners (called
retained earnings or reserves
for a company).

partnership:
When two or more people agree to carry on a business together intending to share the profits.

preference share:
A second class, or type, of share that can be issued by a company in addition to its
ordinary shares.
Preference shares derive their name from the fact that they have certain preferences over the
ordinary shares
- they are paid cash dividends before any can be distributed to ordinary shareholders, and in the event of liquidating the business, preference shares must be redeemed before any money is returned to the ordinary shareholders. Preference shareholders usually do not have voting rights and may be callable by the company, which means that the business can redeem the shares for a certain price per share.

preferred stock:
American term for preference share.

prepaid expenses:
Expenses that are paid in advance, or up-front for future benefits.

price/earnings (P/E) ratio:
The current market price of a capital stock divided by its most recent, or ‘trailing' twelve months
diluted earnings per share (EPS)
, or
basic earnings per share
if the business does not report diluted EPS
.
A low P/E may signal an undervalued share price or a pessimistic forecast by investors.

private equity:
Large-scale pooled funds, usually geared up (see
gearing
) with borrowings, that buy out quoted companies. This takes those companies off the stock market and makes them private, but the companies are often returned to the market after a few years of financial engineering.

product cost:
Equals the purchase cost of goods that are bought and then resold by retailers and wholesalers (distributors).

profit:
Equals sales revenue less all expenses for the period.

profit and loss (P&L) statement:
The
financial statement
that summarises sales revenue and expenses for a period and reports one or more
profit
lines.

profit ratio:
Equals
net income
divided by sales revenue. Measures net income as a percentage of sales revenue.

profit smoothing:
Manipulating the timing of when sales revenue and/or expenses are recorded in order to produce a smoother profit trend year to year.

proxy statement:
The annual solicitation from a company's top executives and board of directors to its shareholders that requests that they vote a certain way on matters that have to be put to a vote at the annual meeting of shareholders. In larger public companies most shareholders cannot attend the meeting in person, so they delegate a proxy (stand-in person) to vote their shares' yes or no on each proposal on the agenda.

quick ratio:
The number calculated by dividing the total of cash,
accounts receivable
, and marketable securities (if any), by total
current liabilities.
This ratio measures the capability of a business to pay off its current short-term liabilities with its cash and near-cash assets. Note that stock and prepaid expenses, the other two current assets, are excluded from assets in this ratio. (Also called the acid-test ratio.)

reducing balance:
One of two basic methods for allocating the cost of a fixed asset over its useful life and for estimating its useful life. Reducing balance (sometimes called accelerated depreciation) allocates greater amounts of depreciation in early years and lower amounts in later years, and also uses short life estimates. For comparison, see
straight-line depreciation
.

reserves:
Another term used for
retained earnings
.

retained earnings:
One of two basic sources of owners' equity of a business (the other being capital invested by the owners). Annual profit (
net income
) increases this account, and distributions from profit to owners decrease the account.

return on assets (ROA):
Equals
earnings before interest and taxes (EBIT)
divided by the
net operating assets
(or by total assets, for convenience), and is expressed as a percentage.

return on equity (ROE):
Equals
net income
divided by the total
book value of owners' equity
, and is expressed as a percentage. ROE is the basic measure of how well a business is doing in providing ‘compensation' on the owners' capital investment in the business.

return on investment (ROI):
A very broad and general term that refers to the income, profit, gain, or earnings on capital investments, expressed as a percentage of the amount invested. The most relevant ROI ratios for a business are
return on assets (ROA)
and
return on equity (ROE).

road show:
Presentations where companies and their advisers pitch to potential investors to ‘sell' them on buying into a business.

sales revenue-driven expenses:
Expenses that vary in proportion to, or as a fixed percentage of, changes in total sales revenue
(total pounds). Examples are sales commissions, credit-card discount expenses, and rent expense and franchise fees based on total sales revenue. (Compare with
sales volume-driven expenses.
)

sales volume-driven expenses:
Expenses that vary in proportion to, or as a fixed amount with, changes in sales volume
(quantity of products sold). Examples include delivery costs, packaging costs, and other costs that depend mainly on the number of products sold or the number of customers served. (Compare with
sales revenue-driven expenses
.)

Securities and Exchange Commission (SEC):
The US federal agency established by the federal Securities Exchange Act of 1934, which has broad jurisdiction and powers over the public issuance and trading of securities (stocks and bonds) by business corporations. In the UK, the London Stock Exchange and the Department of Trade and Industry cover some of the same ground between them.

seed capital:
The initial capital required to start a business and prove that the concept is viable.

sole trader:
Simplest type of business. No shareholders, just the owner's money and borrowings. Also known as a sole proprietor.

statement of cash flows:
See
cash flow statement
.

statement of changes in owners' (shareholders') equity:
More in the nature of a supplementary schedule than a fully-fledged financial statement - but, anyway, its purpose is to summarise the changes in the owners' equity accounts during the year.

stock:
Goods on hand for resale, or held in raw materials, or as work in process. In the US, the term inventory is more commonly used. Stock, in the US, is usually used to describe share capital.