Unit 3 Vocabulary

Depreciation

Non-current assets are recorded at their historical cost (purchase price) in the accounts, yet most non-current assets lose value over time.

Wear and Tear

Non-current assets lose functionality over time. They also appear older and therefore not as valuable.

Obsolescence

As newer items become available, non-current assets owned by a business become less valuable.

Straight Line Method

Calculates the depreciation based on time the non-current asset is used by the firm. This method spreads the depreciation evenly over the useful life of the non-current asset being depreciated.

Statement of Profit & Loss

The purpose of the Profit & Loss Account (income statement) is to record a firm's trading activities over a period of time (usually a year). It helps businesses identify areas for improvement (improve profit margins or reduce losses) and allocate resources, as well as tracking progress and assessing the effectiveness of strategies

Sales Revenue

All the inflows a business makes from the selling of their products

Cost of Sales

Also known as Cost of Goods Sold. These are all the direct costs associated with production costs and what is sold

Gross Profit

The difference between revenue and cost of sales. It shows how well a business is making money from its costs of production.

Expenses

Also known as overheads. It is the outflow, expenses of a business for day-to-day running. They can be marketing, salaries, administration costs.

Profit before interest and tax

This is the profit from all business operations (once all the revenue expenditure is taken from the sales).

Interest

This is the expense on loans. Companies have to pay this. It is out of the control of the business so it is separated from other expenses.

Tax

This is the money paid to the government. It is out of the control of the business and so separated from operational expenses.

Profit for period

This is the actual profit that is made after all direct and indirect costs are paid. This is what is left in the business to give as dividends and/or retain as profit to reinvest in the business.

Dividends

This is the money from profit for period that is given to shareholders. It is only seen between privately and publicly held companies

Retained profit

This is the money kept in the business (for that period only) to reinvest in the business

Intangible Assets

Intangible assets are a type of non-current asset except they are non-physical assets with a monetary value to the business. These assets are protected by using intellectual property rights including: licenses, patents, copyrights, and trademarks.

Share Capital

Finance invested from selling shares

Retained Earnings

Money kept (retained profits) in the business over years to reinvest in the business

Non-Current Assets (Fixed Assets)

These are capital assets that stay in the business for more than one year. Examples are property, equipment, factories, etc.

Accumulated Depreciation

This shows the value up to date on how much the capital assets have lost value (this is due to wear and tear mostly).

Cash

This refers to how much cash the company has on hand (in essence - the money in the bank account the day they do the balance sheet.

Debtors

This is the money that is owed to the business by its customers, but the business has yet to collect. Think of trade credit - when a business lets another company by on credit.

Stock

The value of inventory (work in progress or finished goods a business has in their possession.

Total Assets

This is the total value of all the assets in the business. Non-current assets + current assets

Bank Overdraft

This is the amount of money the business owes to the bank because they have used overdraft as a source of finance.

Trade Creditors

This is the amount of money owed to suppliers. It means that the business has received the goods from the supplier, but still needs to pay for the goods. The business used trade credit as a source of finance.

Other short-term loans

The amount of money that has been borrowed by financial institutions or otherwise that need to be repaid within a year.

Non-Current Liabilities

These are the payments (financial obligations) the business needs to pay over many years

Borrowing - long term

The amount of money that has been borrowed by financial institutions or otherwise that need to be repaid over the course of many years (usually bank loans are for 5-30 years depending on what it was used to finance.

Equity

This section of the balance sheet is made up of the 'wealth' of the business. What the shareholders put in. It includes retained earnings and share capital.

Residual Value

Also known as salvage value or scrap value, this is the monetary value of a non-current asset at the end of its useful life, before it is replaced.

Units of production method

The units of production method of depreciation bases the value of depreciation to a non-current asset on each physical unit of output.

Ratio analysis

Is a financial analysis into the profitability, liquidity, operational efficiency and solvency of a company. The calculations include figures from the financial accounts.

Ratio analysis can indicate a firm's financial performance over time (comparison of different years) and/or competitiveness in an industry (comparison to industry standards and/or competitors)

Gross Profit Margin

GPM shows the value of a firm's gross profit expressed as a percentage of its sales revenue (the formula explained). The HIGHER, the BETTER!

Profit Margin

Shows the percentage of sales turnover that is turned into overall profit

Return on Capital Employed (ROCE)

Is a profitability ratio that measures the financial performance of a firm based on the amount of capital invested.

Liquidity Ratios

Look at the ability for a firm to pay off its short-term debts. It looks at the current assets and current liabilities. A company is looking to have MORE current assets than current liabilities, which indicates that the business is able to pay off short-term debt. The ratios below help to analyse this.

Current Ratio

Refers to the firm's liquid assets and current liabilities.

Can a business cover it's short term debts (within 12 months)?

Acid Test Ratio

Refers to the ability to pay off short-term debts with only debtors and cash NOT inventory (stock)

Efficiency Ratios

also known as debt and equity ratios, it enables a business to calculate the value of a firm's liabilities and debts against its equity. These ratios show how efficiently an organization's resources have been used.

Debtor Days

Measures the number of days it takes on average for customers to pay the business (the business to collect payments).

Creditor Days

Measures the number of days it takes (on average) for the business to pay its suppliers

Gearing Ratio

Measures the extent (percentage) of the capital employed financed by non-current liabilities. measures a firm’s long-term financial structure by comparing non-current liabilities to capital employed. It indicates financial risk and reliance on debt,

Stock Turnover

The rate of stock turnover records the number of times the stock of a business is bought in and resold in a period of time. The lower the amount of capital used in holding stock, the better as this frees up capital to be used elsewhere.

Insolvency

Occurs when businesses are NOT able to pay their short-term debts when they are due

Bankruptcy

Occurs when a business are NOT able to pay their debts and DECLARE formally that they cannot pay. The business has failed and will not continue trading

Contribution per unit

Contribution per unit is the amount of money left over from the sale of a product after the variable costs have been deducted. Another way to say this is the amount that each product contributes to paying off the fixed costs of the business.

Total contribution

It is the amount that all products or services contribute to paying off the fixed costs of the business.

Profit or loss with contribution

It can be calculated using total contribution. Since we know that variable costs are covered with contribution per unit, the business just needs to pay off the fixed costs to make a profit.

Margin of Safety

The measure of the difference between the break-even point and the actual sales a business makes. It allows a business to know how much its sales can drop before it is making a loss.

Profit or loss with costs and revenue

It can be calculated total costs and total revenue. We know from break-even that once total revenue exceeds total costs, the business is making a profit.

Break Even Target Price

Until this point, we have assumed that production was limitless. We assumed that the business could produce any number to break-even, but this is not the reality. Every business or factory has a maximum capacity they can produce.