JaxWorks
Small Business Spreadsheet Factory
Since 1996

 

     
 

Glossary of Financial Terms




JaxWorks is a Microsoft Partner

A | B | C | D | E | F | G | H | I | J | K | L | M
N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Acronyms

 Ratios and Formulas in Customer Financial Analysis


 

- A -

Accounts Payable. Trade accounts of businesses representing amounts owed for goods or services received.

Accounts Receivable. Trade accounts of businesses representing amounts due for goods sold or services rendered.

Accounting. The recording, classifying, summarizing, and interpreting of events of a financial character. These events can include income, expenses, and cash flow.

Accrual-Basis Accounting. An accounting system in which income is recorded when it is earned rather than when it is paid, and expenses are recorded when an obligation is established rather than when the money is paid. 

Acid-test ratio. Also called the quick ratio, the ratio of current assets minus inventories, accruals, and prepaid items to current liabilities.

Addendum. An attachment or exhibit to a written document, such as a contract.

Agent. A person granted the authority to act on behalf of another person or entity, known as the "principal." The actions and decisions of the agent can be binding on the principal.

Age Discrimination in Employment Act (ADEA). A federal law that prohibits employers from discriminating against individuals age 40 or more. This law generally applies to companies with 20 or more employees.

Aging schedule. A table of accounts receivable broken down into age categories (such as 0-30 days, 30-60 days, and 60-90 days), which is used to see whether customer payments are keeping close to schedule.

Alternative Dispute Resolution (ADR). An approach to conflict resolution designed to avoid court proceedings. ADR
traditionally encompasses two main forms: arbitration and mediation.

Americans with Disabilities Act (ADA). A federal law that prohibits discrimination against those with physical or mental disabilities in employment, public services and public places, such as restaurants, hotels and shops. The ADA requires companies with 15 or more employees to make reasonable accommodations to enable qualified disabled employees to perform their job.

Amortization. Paying off debt in regular installments over a period of time, or deducting certain capitalized expenditures over a specified period of time.

Appreciation. The increase in the value of an asset.

Arbitration. A form of alternative dispute resolution in which a neutral third party (an arbitrator) considers the competing parties´ arguments and evidence and renders a decision or award. Arbitration can be binding or non-binding.

Asset. Any possession that has value in an exchange.

Assets. A firm's productive resources.

Audit. A review or examination of an individual´s or organization´s records to determine legal compliance or proper record keeping.

Award. A decision rendered by a court or arbitrator that one party in a dispute is owed money and that the other party or parties are liable.



- B -


Balance sheet
Also called the statement of financial condition, it is a summary of the assets, liabilities, and owners' equity.

Bankruptcy
State of being unable to pay debts. Thus, the ownership of the firm's assets is transferred from the stockholders to the
bondholders.

Break-even analysis
An analysis of the level of sales at which a project would make zero profit.

Budget
A detailed schedule of financial activity, such as an advertising budget, a sales budget, or a capital budget.

Bonds. Securities issued by the U.S. government, corporations, federal agencies, or state or local municipalities. Bonds are sometimes further classified as follows:

Corporate bonds - Debt instruments issued by corporations, as distinct from ones issued by a government agency, typically interest-bearing with a fixed maturity.

High-Yield Bonds - A bond that has a rating of BB or lower and pays a higher yield to compensate for the greater credit risk.

Long-Term Government Bonds - Securities issued by the US government and debt issues of federal agencies having a maturity of 10 years or more.

Mortgage-Backed Bonds - Securities backed by mortgages issued by FMLMC and FNMA or guaranteed by GNMA. Investors receive payments out of the interest and principal on the underlying mortgages.

Municipal bonds - Debt obligation of a state or local government entity. The funds may support general government needs or fund special projects. The interest on these bonds is typically exempt from federal income taxes, and most state and local taxes.

Bonus. A cash award granted to employees by the employer, usually based on personal and/or company performance. Bonuses can also come in the form of extra vacation time, gifts and other nonmonetary awards.

Breach of Contract. A violation of or failure to perform according to the terms and conditions of an agreement.

Business Plan. A planning document that describes a company, its market, its management team, its potential, its competitors, and all other relevant information about its business and its prospects.



- C -

Cash. The value of assets that can be converted into cash immediately.

Cash flow from operations. The sum of net income plus non-cash expenses that were deducted in calculating net income.

Cash Equivalents - Investments of high liquidity and safety with a known market value and a very short-term maturity.
Examples include Treasury bills and money market funds.

CDs - CDs, or certificates of deposit, are interest-bearing debt instruments issued by banks with maturities from a few weeks to several years.

Fixed Annuities - Investment contract sold by an insurance company that guarantees fixed payments, either for life or for a specified period, to the annuitant. The insurer takes both the investment risk and the mortality risk.

T-Notes - T-Notes are negotiable debt obligations of the US government with maturities of 1 to 10 years.

Capital. (1) Assets less liabilities, representing the ownership interest in a business, (2) a stock of accumulated goods, especially at a specified time and in contrast to income received during a specified time period, (3) accumulated goods devoted to the production of goods, and (4) accumulated possessions calculated to bring income.

Capital Expenditures. Business spending on additional plant equipment and inventory.

Cash Discount. An incentive offered by the seller to encourage a buyer to pay within a stipulated time. For example, if the terms are 1%/10/net 30, the buyer may deduct 1 percent from the amount of the invoice (if paid with 10 days); otherwise the full amount is due within 30 days.

Cash Flow. An accounting presentation showing how much of the cash generated by a business remains after both expenses (including interest) and principal repayment on loans are paid. A projected cash flow statement indicates whether the business will have cash to pay its expenses, loans, and make a profit. Cash flows can be calculated for any given period of time, normally done on a monthly basis or yearly basis.

Circulation. The number of copies that a publication distributes or sells. Also refers to the number of people who have an opportunity to observe a piece of outdoor advertising, such as a billboard or poster.
Collateral. Something of value pledged to support the repayment of an obligation or loan. Examples include real estate and certificates of deposit.

Collateral Document. A legal document covering the item(s) pledged as collateral on a loan.

Close. The point during the sales process when the customer agrees to buy a product or service.

Closing. Actions and procedures required to effect the successful conclusion of a business transaction, such as a real estate purchase or loan consummation.

Cold Call. An unscheduled contact, either on the phone or in person, between a seller and a prospective customer.

Common Law. Law made by judges in individual cases, rather than by the legislature.

Compensation. Direct and indirect monetary and nonmonetary rewards given to employees based on the value of the job, their personal contributions and their performance.

Compromise. The settlement of a dispute or claim.

Consideration. The inducement to a contract. Some right, interest, profit, or benefit accruing to one party, or some
forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other.

Contingency Fee. A common legal fee arrangement that relies on the collection of monetary damages for the plaintiff before any legal fees are owed. Most common in litigation (such as in personal injury lawsuits), it allows the client to receive legal services while paying the attorney little or no money up front.

Contingent Liability. A potential obligation that may be incurred dependent upon the occurrence of a future event. Two  examples are: (1) the liability of a guarantor of a promissory note if the primary borrower fails to pay as agreed and (2)  the liability that would be incurred if a pending lawsuit is resolved in the other party's favor.

Controlled Circulation. Publications, generally business oriented, delivered only to readers who have some special  qualifications. Generally, these publications are free to the qualified recipients, who must complete registration  questionnaires in order to receive them. Also called "qualified circulation."

Copyright. An exclusive ownership interest in an artistic or literary work. The term "literary work" includes computer  software and other information stored in electronic form. Copyright is often noted by the following example: "Copyright© 2006 by JaxWorks.com."

Corporation. A form of organization that provides its owners and shareholders with certain rights and privileges, including protection from personal liability, if proper steps are followed. Corporations may take a number of forms, depending on the goals and objectives of the founders. Types include C, S and nonprofit corporations. Corporations are regarded as "persons" in the eyes of the law and may thus sue and be sued, own property, borrow money and hire employees.

Cost of Goods Sold. This term represents the cost of buying raw materials and producing the goods that a company sells. It also includes the cost of the company´s labor force and overhead costs.

Credit Rating. A formal evaluation of an individual or a company´s credit history and capability of repaying debt.

Credit Score. A statistical summary of the individual pieces of information on a credit report. A credit score predicts how likely it is that a company or individual will repay debts. Lenders use credit scores to determine whether to extend credit and at what interest rate. Also called a risk score.

Current Ratio. The ratio of the company´s current assets to its current liabilities. A current ratio of less than 1-to-1  typically indicates a poor credit risk. A current ratio of greater than 2-to-1 typically indicates a good credit risk.

Customer. Someone who has bought or made the decision to buy a product or service.

Cyclical Industry. An industry that has natural high and low sales periods based on the time of year, season or other
factors.

C Corporation. A corporation where the entity is taxed separately from its owners under subchapter C of the Internal Revenue Code.




- D -

 

Damages. A cash compensation ordered by a court or arbitrator to offset losses or suffering caused by another´s fault or negligence. Damages are a typical request made of a court or arbitrator when persons sue for breach of contract or tort.

Debenture. Debt instrument evidencing the holder's right to receive interest and principal installments from the debtor.

Debt Financing. The provision of long term loans to small business concerns in exchange for debt securities or a note.

Decision Maker. The person within a company who ultimately decides which products or services to buy.

Deed of Trust. A document that, when properly delivered, transfers a security interest in real property.

Defaults. The nonpayment of principal and/or interest on the due date as provided by the terms and conditions of a promissory note or loan agreement.

Demand Letter. A letter from a lawyer on behalf of a client that demands payment or some other action. Demand letters often threaten litigation if the other party does not perform.

Demographic. A descriptive classification for consumers, such as age, sex, income, education, household size, home ownership or other defining characteristics.

Depreciation. An accounting procedure that spreads the cost of purchasing an asset over the useful lifetime of the asset.

Direct Mail. Marketing or advertising materials sent directly to a prospective customer via the US Postal Service or a  private delivery company.

Direct Marketing. The process of sending promotional messages directly to individual consumers, rather than via a mass medium. Includes methods such as direct mail and telemarketing.

Disability Benefits. Benefits paid to an employee who cannot work because of disability, usually limited to what is not  covered by workers compensation. Disability benefits are usually a percentage of the employee´s prior income and generally run for a limited time.

Doing Business As (DBA). A situation in which a business owner operates a company under a different name than the one under which it is incorporated. The owner typically must file a fictitious name statement or similar document with the appropriate county or state agency.



- E -

 

EBITDA. Earnings before interest, taxes, depreciation, and amortization.

Employee Retirement Income Security Act (ERISA). A broad-reaching law that establishes the rights of pension plan  participants, standards for the investment of pension plan assets, and requirements for the disclosure of plan provisions and funding.

Employee Manual. A handbook that describes a company´s personnel procedures, policies and benefits.

Employer ID Number (EIN). An identification number assigned to businesses for taxpaying purposes by the IRS or state taxing authorities. An Employer ID Number is required for partnerships, corporations, and trusts, and it may be required for sole proprietorships that have employees. Also called a Federal ID Number or Taxpayer ID Number.

Employment Agreement. An agreement that sets forth the rights and obligations of employees and employers. Typical employment agreements oblige employees to keep trade secrets confidential and to not solicit other employees after their departure.

Entrepreneur. One who assumes the financial risk of the initiation, operation, and management of a given business
undertaking.

Equal Employment Opportunity (EEO). Federal legislation prohibiting employment discrimination based on age, race, sex, religion or ethnic background.

Equal Employment Opportunity Commission (EEOC). The federal agency responsible for handling workplace discrimination complaints. Many states have comparable agencies.

Equal Pay Act. Federal legislation that prohibits certain employers from paying different wages to men and women who perform the same work in similar working conditions.

Equity. An ownership interest in a business. For example, stock in a corporation represents equity in the corporation.

Equity Financing. The provision of funds for capital or operating expenses in exchange for capital stock, stock purchase warrants, and/or options in the business financed, without any guaranteed return, but with the opportunity to share in the company's profits.

ESOP (Employee Stock Ownership Plan). A retirement-type plan in which a trust holds stock in the employees´ names. Employees receive cash from the stock only when they leave the company or perhaps when the company is sold.

Exempt Employee. Employees who are not bound to overtime regulations and minimum wage laws. Who is exempt depends on level of responsibility or professional status.

Exit Interview. An interview conducted at the end of an employee´s term of employment to obtain employment feedback and to remind the employee of his or her confidentiality obligations.



- F -

 

401(k) Plan. A tax-deferred retirement plan designed to encourage long-term retirement savings. Some companies provide contributions as an employee benefit.

Fair Debt Collection Practices Act. A federal law that specifies what debt collectors can and cannot do to try to collect late payments.

Fair Labor Standards Act (FLSA). A federal law that defines the 40-hour workweek, the federal minimum wage, overtime pay, record keeping and child labor standards affecting private sector, federal, state and local government workers.

Fair Use. A legal doctrine that authorizes use of copyrighted materials for certain purposes without the copyright owner´s permission.

Family and Medical Leave Act (FMLA). A federal law requiring employers to provide eligible employees with unpaid leave during a year´s time for the birth or adoption of a child, family health needs or personal illness. The FMLA generally applies to all public agencies, including state, local and federal employers; private companies that employ 50 or more people; and public schools.

FICA (Federal Insurance Contributions Act). A payroll deduction for Social Security required by the federal government.

Financial Reports. Reports concerning the financial aspects of a business, such as:

(1) Balance Sheet - A report of the status of a firm's assets, liabilities and owner's equity at a given time.

(2) Income Statement - A report of revenue and expense which shows the results of business operations or net income for a specified period of time.

(3) Cash Flow - A report which analyzes the actual or projected source and disposition of cash during a past or future
accounting period.

Financing. New funds provided to a business, either by way of equity infusion, or loans.

Fixed Costs. Costs of doing business, such as rent and utilities that remain generally the same regardless of the amount of sales of goods or services.

Flow Chart. A graphical representation for the definition, analysis, or solution of a problem, in which symbols are used to represent operations, data, flow, equipment, etc.

Foot Traffic. Consumer activity produced by visitors at stores, trade show exhibits or by popular retail locations.

Foreclosure. The act by the mortgagee or trustee upon default, in the payment of interest or principal of a mortgage of  enforcing payment of the debt by selling the underlying secured property.

Form W4, Employee's Withholding Allowance Certificate. An IRS form completed by the employee and used by the employer to determine the amount of income tax to withhold.

Franchising. A relationship in which the franchisor provides a licensed privilege to the franchise to do business and offers assistance in organizing, training, merchandising, marketing, and managing in return for a consideration. Examples of franchises include Burger King and Taco Bell.

Freedom of Information Act. The FOIA, enacted in 1966, generally provides that any person has a right of access to federal agency records.



- G -

 

Guarantee. A promise to step in and perform another´s obligation if that person should fail or default.

Guarantor. A person who makes a legally binding promise either to pay another person´s obligation or to perform another person´s duty if that person defaults or fails to perform.



- H -

 

Health Maintenance Organization. A system of managed health care in which patients must see approved health care providers. HMOs typically offer coverage with no deductibles and low per-visit fees.



- I -

 

Incentive Stock Options (ISOs). Stock options granted to employees that are taxed as capital gains rather than income if the employee meets the required holding period before selling them. Also called statutory stock options and qualified stock options.

Income Statement. A record of the financial performance of a company over a period of time. It records all the income  generated by the business during the period and deducts all its expenses for the same period to arrive at net income, or the profit for the period.

Independent Contractor. A worker who works on a specific project for a specified period of time. Independent contractors are not subject to tax withholdings and usually don´t receive benefits granted to full-time employees.

Infringement (of copyright). Any unauthorized use of a copyrighted work other than fair use.

Infringement (of patent). Violation of a patent through production, use or sale of a patented invention or its functional  equivalent without the patent holder´s permission.

Infringement (of trademark). Unauthorized use of a protected trademark or service mark or use of a confusingly similar mark.

Inquiries. Consumer response to a company´s advertising, or to other promotional activities such as coupons. Used to measure the effectiveness of promotions.

Inserts. Extra printed pages inserted loosely into printed pieces. Often inserts are advertising supplements to a newspaper or magazine.

Internal Revenue Service (IRS). The federal agency that collects income taxes in the United States.  INS Form I-9. The form used by the Immigration and Naturalization Service to verify an employee´s eligibility to work in the United States.

Insolvency. The inability of a borrower to meet financial obligations as they mature, or having insufficient assets to pay  legal debts.

Interest. (1) An amount paid a lender for the use of funds, or (2) cost of using credit or another person´s or company´s  money. Interest is usually calculated as a rate per a period of time, typically a year.

Interest Rate. Percentage of a sum of money charged for the use of the money. Borrowing $100 for one year at a 10 percent simple interest rate would cost $10.

Internet. A network of networks, built upon a set of widely used software protocols that links millions of computers around the world. Services such as email and the Web use the Internet to transfer data.

Intranet. A private corporate network built with Internet-based protocols and software applications.

Invoice. A bill prepared by the seller of goods or services. Invoices tell purchasers how much they owe.

IRS Form 1099-MISC. The tax form sent to the IRS and the independent contractor at the end of the year when an independent contractor´s annual wages meet or exceed $600.

IRS Form W-4. The IRS form used to record filing status and withholding allowances. Also known as the Employee Withholding Tax Certificate.




- J -

 

Joint Venture. An agreement between two or more partners ("joint venturers") to pursue collaboratively a particular project or business, with a sharing of profits or losses.

Judgment. Judicial determination of the existence of an indebtedness or other legal liability.

Judgment by Confession. The act of debtors permitting judgment to be entered against them for a given sum with a statement to that effect, without the institution of legal proceedings.

Jurisdiction. The authority of a court to hear and decide a case. For a decision to be valid, a court must have both "subject matter jurisdiction" (the ability to hear the type of case at issue) and "personal jurisdiction" (authority over the parties).



- K-

 

Key Person Insurance - Business-owned life insurance contract typically on the lives of principal officers.




- L-

 

Lease. A contract by which a tenant (the "lessee") takes possession of office space, furniture, equipment or other property for a specified rent and specified amount of time. At the end of a lease, the property reverts back to its owner (the "lessor").

Lessee. The renter or tenant.

Lessor. The landlord or owner.

Letter of Credit. A document issued by a bank guaranteeing payment of a customer´s debt up to a set amount over a set period of time. Letters of credit are used extensively in international trade.

Letter of Intent (LOI). An agreement, usually nonbinding, documenting the general terms of a proposed business relationship. Often used as a prelude to a binding, definitive agreement.

Liability. Any debt or obligation due now or potentially in the future. Liability is synonymous with legal responsibility.

Lien. A charge upon or security interest in real or personal property maintained to ensure the satisfaction of a debt or duty ordinarily arising by operation of law.

Limited Liability Company (LLC). A flexible business structure, popular with small businesses, offering owners the advantage of limited personal liability and the choice of being taxed like a partnership or a corporation.

Limited Liability Partnership (LLP). A type of partnership recognized in many states that protects individual partners from personal liability for negligent acts committed by other partners and employees not under their direct control. Some states restrict this type of partnership to professionals, such as lawyers, accountants and architects.

List Broker. A person or company who prepares, rents and maintains mailing lists.

Litigation. Lawsuits instituted through the judicial process.

Loan Agreement. An agreement for the borrowing of money, typically containing pertinent terms, conditions, covenants and restrictions.

Logo. A symbol that a company uses to represent itself or its brand.

Long-Term Debt. Obligations or liabilities that a company owes in one year or more.



- M-

 

Marketing Plan. A company plan for marketing products and services and increasing sales.

Market Share. The percentage of a product category´s sales, in dollars or units, that a particular brand, product line or  company controls.

Marketing Communications. The process and techniques involved in marketing, promoting or selling products or services through creative, visual or written communications. Also known as "marcom."

Maturity. In general, the period and date when payment of a loan is due. As applied to securities and commercial paper, the period and date when payment of principal is due.

Maturity Extension. Extension of payment beyond the original date established for repayment of a loan.

Mediation. A form of alternative dispute resolution in which a neutral party (a mediator) seeks to promote and negotiate a settlement between opposing parties in a dispute. There is no mechanism to compel the parties to settle; they must voluntarily agree to any settlement.

Medium. A type of publication or communications method that conveys news, entertainment and advertising to an audience. Examples include newspapers, television, magazines, radio, billboards and the Internet.

Merger. Typically, a combination of two or more corporations into one corporation.

Mortgage. An instrument giving legal title to secure the repayment of a loan made by the mortgagee (lender).



- N-

 

Nondisclosure Agreement (NDA). A contract in which a person or business agrees to maintain the confidentiality of proprietary information or trade secrets and not disclose such information without authorization. Employees, consultants, business partners and investors are often asked to sign nondisclosure agreements.

Nonexempt Employee. Employees who are protected by wage laws that mandate payment for every hour of overtime worked.

Nonprofit Corporation. A form of corporation in which no stockholder or trustee shares in profits or losses and which usually exists to accomplish some charitable or educational function. These organizations are exempt from corporate income taxes, and donations to these groups may be tax deductible.

Nonqualified Stock Options (NSOs). Nonqualified stock options may be granted to employees, consultants, contractors and others. When nonqualified stock options are exercised the holder must pay ordinary income tax on them, even if the shares have not yet been sold.

Notes Receivable. A secured or unsecured receivable evidenced by a note.




- O-

 




- P-

 

Parent Company. A company that owns a majority stake (51 percent or more) of another company´s shares. It may have its own operations, or it may have been set up solely for the purpose of owning the operating company.

Partnership. A legal relationship existing between two or more persons or entitites contractually associated as joint  principals in a business.

Patent. A patent secures to an inventor the exclusive right to make, use and sell an invention for a designated period of time.

Pay Period. The frequency with which payroll is processed and paychecks are issued.

Performance Review. A mechanism for regular discussion and evaluation of an employee´s job performance.

Power of Attorney. A written authorization that lets one person act as an agent for another and to make binding decisions for the principal. A power of attorney can be limited to specific types of decisions or it can be general.

Preferred Stock. A class of stock with a liquidation preference before payment is made to the common stock holders. Preferred stock is the security most used by venture capital investors.

Prime Rate Interest rate which is charged business borrowers having the highest credit ratings, for short term borrowing.

Profit Sharing. Employee incentives in which a company distributes or receives a portion of the business´s profits to  employees.

Proprietorship. The most common legal form of business ownership; about 85 percent of all small businesses are  proprietorships. The liability of the owner is unlimited in this form of ownership.

Proxy. A right given to an agent, most often in the context of shareholder voting in corporations.

Public Domain. A copyright term that means a particular work is free for all to use without permission. Works in the public domain include those that were never copyrighted, those for which the copyright has expired and public documents.

Publicity. Information with news value used to promote a product, service or idea in the media.

Public Relations. Communication with various sectors of the public to influence their attitudes and opinions in the interest of promoting a person, product or idea.

Purchase Order. A form that contains pricing, quantity and other purchasing information.



- Q-

 

Qualified Opinion - AUDIT opinion that states, except for the effect of a matter to which a qualification relates, the FINANCIAL STATEMENTS are fairly presented in accordance with GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP). The auditor is required to qualify when there is a scope limitation.

Quasi-Reorganization - Type of reorganization in which, with shareholder approval, the management revalues ASSETS and eliminates the DEFICIT (increased by asset devaluations if any) by charging it to other EQUITY accounts without the creation of a new corporate entity or without court intervention.



- R-

 

Return on Investment. The amount of profit (return) based on the amount of resources (funds) used to produce it. Also, the ability of a given investment to earn a return for its use.



- S-

 

SBA. The US Small Business Administration (SBA), created by Congress in 1953 to help America's entrepreneurs form successful small business enterprises. See www.SBA.gov.

Salary. Regular compensation paid to an employee as a condition of employment. Salary is generally computed on an annual or a monthly basis.

Sexual Harassment. Uninvited sexual advances or related conduct that creates an intimidating, hostile or offensive work environment. Sexual harassment is prohibited by the federal Civil Rights Act of 1991 as well as by various state laws.

Shareholder Agreement. A written agreement between a corporation and its shareholders governing the nature of the  relationship and the conduct of certain corporate activities (such as distribution of profits and resolution of shareholder  disputes).

Small Claims Court. A court intended to simplify and expedite the resolution of minor disputes.

Social Security Tax. Provides benefits for retired workers and their dependents as well as for the disabled and their  dependents.

Stock Option. A right to buy a given amount of company stock at a given price for a given period of time.

Sublease. The act of a tenant leasing the property it is leasing to yet another tenant, called a sublessee.

Subsidiary. A company owned by a parent company, a subsidiary is a separate legal entity listed as a corporation or LLC that is required to file its own taxes.

S Corporation. A form of corporate organization where the profits of the entity pass through to shareholders and are taxed on their personal returns under subchapter S of the Internal Revenue Code.
 


- T-

 

Temporary Employee. An employee, often hired and paid by a third party, who fills in staffing shortages caused by special projects, seasonal coverage, leaves of absence or other reasons.

Tenant Improvements. Refurbishing a rental space for a new tenant.

Tort. A civil wrong or injury that results in a legal action for damages to rectify the wrong.

Trademark. A name, phrase, logo, image or combination of images used to identify and distinguish a business from others in the marketplace.
 


- U-

 

 


- V-

 

Venture Capital. Money used to support new or unusual commercial undertakings; equity, risk or speculative capital.
 


- W-

 

Working Capital - Excess of CURRENT ASSETS over CURRENT LIABILITIES.

 


- X-

 


- Y-

 


- Z-

 

Z-Score:
ALTMAN, EDWARD developed the "ALTMAN Z-SCORE" by examining 85 manufacturing companies. Later, additional "Z-Scores" were developed for private manufacturing companies (Z-Score - Model A) and another for general/service firms (Z-Score - Model B). JaxWorks selects the "Z-Score" appropriate for each firm based upon the questionnaire input from the listing company. A "Z-Score" is only as valid as the data from which it was derived i.e. if a company has altered or falsified their financial records/books, a "Z-Score" derived from those "cooked books" is of lesser use.

ORIGINAL "Z-SCORE" [For Public Manufacturer] If the "Z-Score" is 3.0 or above - bankruptcy is not likely. If the "Z-Score" is 1.8 or less - bankruptcy is likely. A score between 1.8 and 3.0 is the gray area. Probabilities of bankruptcy within the above ranges are 95% for one year and 70% within two years. Obviously, a higher "Z-Score" is desirable.

MODEL A "Z-SCORE" [For Private Manufacturer] "Model A" of Altman's Z-Score is appropriate for a private manufacturing firm. "Model A" should not be applied to other companies. A "Z-Score of 2.90 or above indicates that bankruptcy is not likely, but a "Z-Score" of 1.23 or below is a strong indicator that bankruptcy is likely. Probabilities of bankruptcy in the above ranges are 95% for one year and 70% within two years. Obviously, a higher "Z-Score" is desirable.

Model B "Z-SCORE" [For Private General Firm] Edward Altman developed this version of the "ALTMAN Z-SCORE" to predict the likelihood of a privately owned non-manufacturing company going bankrupt within one or two years. "Model B" of Altman's "Z-Score" is appropriate for a private general (non-manufacturing) firm. Model B should not be applied to other companies. A "Z-Score" of 1.10 or lower indicates that bankruptcy is likely, while a score of 2.60 or above can be an indicator that bankruptcy is not likely. A score between the two is the gray area. Probabilities of bankruptcy in the above ranges are 95% for one year and 70% within two years. Again, obviously, a higher "Z-Score" is desirable.

ALTMAN Z-SCORE reliably predicts whether or not a company is likely to enter into bankruptcy within one or two years:

If the Z-Score is 3.0 or above - bankruptcy is not likely.
If the Z-Score is 1.8 or less - bankruptcy is likely.
A score between 1.8 and 3.0 is the gray area, i.e., a high degree of caution should be used.
Probabilities of bankruptcy within the above ranges are 95% within one year and 70% within two years; obviously, a higher Z-Score is desirable. It is best to assess each individual company's Z-Score against that of the industry. In low margin industries it is possible for Z-Scores to fall below the above. In such cases a trend comparison to the industry over consecutive time periods may be a better indicator.

It should be remembered that a Z-Score is only as valid as the data from which it was derived i.e. if a company has altered or falsified their financial records/books, a Z-Score derived from those "cooked books" is of lesser use.


Acronym Listing

  • CPA = Certified Public Accountant

  • EDP = electronic data processing

  • EPS = earnings per share

  • FASB = Financial Accounting Standards Board

  • FICA = Federal Insurance Contributions Act

  • FOB = free-on-board

  • FCPA = Foreign Corrupt Practices Act

  • GAAP = generally accepted accounting principles

  • GAAS = generally accepted auditing standards

  • JIT = just-in-time inventory

  • LIFO = last-in, first-out

  • LCM = lower cost or market

  • MACRS = modified accelerated cost recovery system

  • NSF = not sufficient funds

  • P/E = price-earnings

  • ROI = return on investment

  • SEC = Securities and Exchange Commission

  • SYD = sum-of-the-years-digits (depreciation method)

 


Ratios and Formulas in Customer Financial Analysis

Financial statement analysis is a judgmental process. One of the primary objectives is identification of major changes in trends, and relationships and the investigation of the reasons underlying those changes. The judgment process can be improved by experience and the use of analytical tools. Probably the most widely used financial analysis technique is ratio analysis, the analysis of relationships between two or more line items on the financial statement. Financial ratios are usually expressed in percentage or times. Generally, financial ratios are calculated for the purpose of evaluating aspects of a company's operations and fall into the following categories:

  • liquidity ratios measure a firm's ability to meet its current obligations.

  • profitability ratios measure management's ability to control expenses and to earn a return on the resources committed to the business.

  • leverage ratios measure the degree of protection of suppliers of long-term funds and can also aid in judging a firm's ability to raise additional debt and its capacity to pay its liabilities on time.

  • efficiency, activity or turnover ratios provide information about management's ability to control expenses and to earn a return on the resources committed to the business.

A ratio can be computed from any pair of numbers. Given the large quantity of variables included in financial statements, a very long list of meaningful ratios can be derived. A standard list of ratios or standard computation of them does not exist. The following ratio presentation includes ratios that are most often used when evaluating the credit worthiness of a customer. Ratio analysis becomes a very personal or company driven procedure. Analysts are drawn to and use the ones they are comfortable with and understand.

Liquidity Ratios

Working Capital
Working capital compares current assets to current liabilities, and serves as the liquid reserve available to satisfy contingencies and uncertainties. A high working capital balance is mandated if the entity is unable to borrow on short notice. The ratio indicates the short-term solvency of a business and in determining if a firm can pay its current liabilities when due.

  • Formula

    Current Assets - Current Liabilities

    Acid Test or Quick Ratio
    A measurement of the liquidity position of the business. The quick ratio compares the cash plus cash equivalents and accounts receivable to the current liabilities. The primary difference between the current ratio and the quick ratio is the quick ratio does not include inventory and prepaid expenses in the calculation. Consequently, a business's quick ratio will be lower than its current ratio. It is a stringent test of liquidity.

  • Formula

    Cash + Marketable Securities + Accounts Receivable
    Current Liabilities

    Current Ratio
    Provides an indication of the liquidity of the business by comparing the amount of current assets to current liabilities. A business's current assets generally consist of cash, marketable securities, accounts receivable, and inventories. Current liabilities include accounts payable, current maturities of long-term debt, accrued income taxes, and other accrued expenses that are due within one year. In general, businesses prefer to have at least one dollar of current assets for every dollar of current liabilities. However, the normal current ratio fluctuates from industry to industry. A current ratio significantly higher than the industry average could indicate the existence of redundant assets. Conversely, a current ratio significantly lower than the industry average could indicate a lack of liquidity.

  • Formula

    Current Assets
    Current Liabilities

    Cash Ratio
    Indicates a conservative view of liquidity such as when a company has pledged its receivables and its inventory, or the analyst suspects severe liquidity problems with inventory and receivables.

  • Formula

    Cash Equivalents + Marketable Securities
    Current Liabilities

    Profitability Ratios

    Net Profit Margin (Return on Sales)
    A measure of net income dollars generated by each dollar of sales.

  • Formula

    Net Income *
    Net Sales

    * Refinements to the net income figure can make it more accurate than this ratio computation. They could include removal of equity earnings from investments, "other income" and "other expense" items as well as minority share of earnings and nonrecuring items.

    Return on Assets
    Measures the company's ability to utilize its assets to create profits.

  • Formula

    Net Income *
    (Beginning + Ending Total Assets) / 2

    Operating Income Margin
    A measure of the operating income generated by each dollar of sales.

  • Formula

    Operating Income
    Net Sales

    Return on Investment
    Measures the income earned on the invested capital.

  • Formula

    Net Income *
    Long-term Liabilities + Equity

    Return on Equity
    Measures the income earned on the shareholder's investment in the business.

  • Formula

    Net Income *
    Equity

    Du Pont Return on Assets
    A combination of financial ratios in a series to evaluate investment return. The benefit of the method is that it provides an understanding of how the company generates its return.

  • Formula

    Net Income *
    Sales

    x

    Sales
    Assets

    x

    Assets
    Equity

    Gross Profit Margin
    Indicates the relationship between net sales revenue and the cost of goods sold. This ratio should be compared with industry data as it may indicate insufficient volume and excessive purchasing or labor costs.

  • Formula

    Gross Profit
    Net Sales

    Financial Leverage Ratio

    Total Debts to Assets
    Provides information about the company's ability to absorb asset reductions arising from losses without jeopardizing the interest of creditors.

  • Formula

    Total Liabilities
    Total Assets

    Capitalization Ratio
    Indicates long-term debt usage.

  • Formula

    Long-Term Debt
    Long-Term Debt + Owners' Equity

    Debt to Equity
    Indicates how well creditors are protected in case of the company's insolvency.

  • Formula

    Total Debt
    Total Equity

    Interest Coverage Ratio (Times Interest Earned)
    Indicates a company's capacity to meet interest payments. Uses EBIT (Earnings Before Income and Taxes)

  • Formula

    EBIT
    Interest Expense

    Long-term Debt to Net Working Capital
    Provides insight into the ability to pay long term debt from current assets after paying current liabilities.

  • Formula

    Long-term Debt
    Current Assets - Current Liabilities

    Efficiency Ratios

    Cash Turnover
    Measures how effective a company is utilizing its cash.

  • Formula

    Net Sales
    Cash

    Sales to Working Capital (Net Working Capital Turnover)
    Indicates the turnover in working capital per year. A low ratio indicates inefficiency, while a high level implies that the company's working capital is working too hard.

  • Formula

    Net Sales
    Average Working Capital

    Total Asset Turnover
    Measures the activity of the assets and the ability of the business to generate sales through the use of the assets.

  • Formula

    Net Sales
    Average Total Assets

    Fixed Asset Turnover
    Measures the capacity utilization and the quality of fixed assets.

  • Formula

    Net Sales
    Net Fixed Assets

    Days' Sales in Receivables
    Indicates the average time in days, that receivables are outstanding (DSO). It helps determine if a change in receivables is due to a change in sales, or to another factor such as a change in selling terms. An analyst might compare the days' sales in receivables with the company's credit terms as an indication of how efficiently the company manages its receivables.

  • Formula

    Gross Receivables
    Annual Net Sales / 365

    Accounts Receivable Turnover
    Indicates the liquidity of the company's receivables.

  • Formula

    Net Sales
    Average Gross Receivables

    Accounts Receivable Turnover in Days
    Indicates the liquidity of the company's receivables in days.

  • Formula

    Average Gross Receivables
    Annual Net Sales / 365

    Days' Sales in Inventory
    Indicates the length of time that it will take to use up the inventory through sales.

  • Formula

    Ending Inventory
    Cost of Goods Sold / 365

    Inventory Turnover
    Indicates the liquidity of the inventory.

  • Formula

    Cost of Goods Sold
    Average Inventory

    Inventory Turnover in Days
    Indicates the liquidity of the inventory in days.

  • Formula

    Average Inventory
    Cost of Goods Sold / 365

    Operating Cycle
    Indicates the time between the acquisition of inventory and the realization of cash from sales of inventory. For most companies the operating cycle is less than one year, but in some industries it is longer.

  • Formula

    Accounts Receivable Turnover in Days
    + Inventory Turnover in Day

    Days' Payables Outstanding
    Indicates how the firm handles obligations of its suppliers.

  • Formula

    Ending Accounts Payable
    Purchases / 365

    Payables Turnover
    Indicates the liquidity of the firm's payables.

  • Formula

    Purchases
    Average Accounts Payable

    Payables Turnover in Days
    Indicates the liquidity of the firm's payables in days.

  • Formula

    Average Accounts Payable
    Purchases / 365

    Additional Ratios

    Altman Z-Score
    The Z-score model is a quantitative model developed in 1968 by Edward Altman to predict bankruptcy (financial distress) of a business, using a blend of the traditional financial ratios and a statistical method known as multiple discriminate analysis.

    The Z-score is known to be about 90% accurate in forecasting business failure one year into the future and about 80% accurate in forecasting it two years into the future. See Altman Z-score Calculators.

  • Formula

    Z =

    1.2
    +1.4
    +0.6
    +0.999
    +3.3

    x
    x
    x
    x
    x

    (Working Capital / Total Assets)
    (Retained Earnings / Total Assets)
    (Market Value of Equity / Book Value of Debt)
    (Sales / Total Assets)
    (EBIT / Total Assets)


    Z-score

    Probability of Failure

    less than 1.8
    greater than 1.81 but less than 2.99
    greater than 3.0

    Very High
    Not Sure
    Unlikely

    Bad-Debt to Accounts Receivable Ratio
    Bad-debt to Accounts Receivable ratio measures expected uncollectible credit sales. An increase in bad debts is a negative sign, since it indicates greater realization risk in accounts receivable and possible future write-offs.

  • Formula

    Bad Debts
    Accounts Receivable

    Bad-Debt to Sales Ratio
    Bad-debt ratios measure expected uncollectible credit sales. An increase in bad debts is a negative sign, since it indicates greater realization risk in accounts receivable and possible future write-offs.

  • Formula

    Bad Debts
    Sales

    Book Value per Common Share
    Book value per common share is the net assets available to common stockholders divided by the shares outstanding, where net assets represent stockholders' equity less preferred stock. Book value per share tells what each share is worth per the books based on historical cost.

  • Formula

    (Total Stockholders' Equity - Liquidation Value of Preferred Stocks - Preferred Dividends in Arrears) divided by:
    Common Shares Outstanding

    Common Size Analysis
    In vertical analysis of financial statements, an item is used as a base value and all other accounts in the financial statement are compared to this base value.

    On the balance sheet, total assets equal 100% and each asset is stated as a percentage of total assets. Similarly, total liabilities and stockholder's equity are assigned 100%, with a given liability or equity account stated as a percentage of total liabilities and stockholder's equity.

    On the income statement, 100% is assigned to net sales, with all revenue and expense accounts then related to it.

    Cost of Credit
    The cost of credit is the cost of not taking credit terms extended for a business transaction. Credit terms usually express the amount of the cash discount, the date of its expiration, and the due date. A typical credit term is 2 / 10, net / 30. If payment is made within 10 days, a 2 percent cash discount is allowed: otherwise, the entire amount is due in 30 days. The cost of not taking the cash discount can be substantial.

  • Formula

    % Discount
    100 - % Discount

    x

    360
    Credit Period - Discount Period

    Example
    On a $1,000 invoice with terms of 2 /10 net 30, the customer can either pay at the end of the 10 day discount period or wait for the full 30 days and pay the full amount. By waiting the full 30 days, the customer effectively borrows the discounted amount for 20 days.

      $1,000 x (1 - .02) = $980

    This gives the amount paid in interest as:

      $1,000 - 980 = $20

    This information can be used to compute the credit cost of borrowing this money.

    % Discount
    100 - % Discount

    x

     

    360
    Credit Period - Discount Period

    =    2
          98

    x

    360
    20

    =    .3673

    As this example illustrates, the annual percentage cost of offering a 2/10, net/30 trade discount is almost 37%.

    Current-Liability Ratios
    Current-liability ratios indicate the degree to which current debt payments will be required within the year. Understanding a company's liability is critical, since if it is unable to meet current debt, a liquidity crisis looms. The following ratios are compared to industry norms.

  • Formulas

    Current to Non-current

    =

    Current Liabilities
    Non-current Liabilities

    Current to Total

    =

    Current Liabilities
    Total Liabilities

    Rule of 72
    A rule of thumb method used to calculate the number of years it takes to double an investment.

  • Formula

    72
    Rate of Return

    Example
    Paul bought securities yielding an annual return of 9.25%. This investment will double in less than eight years because,

    72
    9.25

    = 7.78 years