Accounting and Finance Glossary 2005
Term
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Absorption costing
Absorption costing is a method of identifying and ascertaining the cost of products or services. This is done by including both fixed and
variable costs. The absorption method of costing can be contrasted with variable or marginal costing methods where costs of products or
services are calculated using variable costs only. The absorption costing method requires the choice of an “absorption basis” by which fixed
costs can be allocated appropriately. For example, the fixed costs of factory equipment repairs and maintenance may be allocated to the
cost of producing specific products on the basis of their use of machine time. In another example, the cost of factory rent and rates may be
allocated to products based on the amount of factory space that their production takes up.
Accounting
Accounting is a difficult term to define. However, it is formally defined by the American Accounting Association as “The classification and
recording of monetary transactions, the presentation and interpretation of the results of those transactions in order to assess performance
over a period and the financial position at a given date, and the monetary projection of future activities arising from alternative planned
courses of action”. Using this definition, accounting can be seen to be about the identification and recording of business transactions as a
way of assisting the management and planning of a business.
Accounting concepts
Accounting concepts are the principles that guide the preparation of accounting information. These fundamental accounting concepts are
best considered as the “building blocks” on which historical accounting information. The fundamental accounting concepts are generally
taking to include “prudence”, “consistency”, “accruals” and “going concern”.
Accounting policies
Accounting policies are the specific accounting bases selected and consistently followed by a business. Accounting policies need to be
appropriate to the circumstances of a business so that, when applied to accounting transactions, the resulting accounting information
presents fairly its results and financial position. Accounting policies are largely governed by the application of accounting standards.
However, there remains a large amount of subjectivity that needs to be applied when determining how to apply accounting policies.
Accounting standards
Accounting standards are authoritative statements of how particular types of transaction and other events should be reflected in financial
statements. Accordingly, compliance with accounting standards will normally be necessary for financial statements to give a “true and fair
view”. When preparing accounts in the UK, businesses must take account of statements issued by the Accounting Standards Board. These
require the adoption of certain accounting principles and methods. There are currently two forms of Accounting Standards in the UK Financial Reporting Standards (FRSs) and Statements of Standard Accounting Practice (SSAPs). The only difference between these is that
SSAPs were issued prior to 1990. Since that date, the name has been changed to FRS. Accounting standards apply to all companies, and
other kinds of entities that prepare accounts that are intended to provide a true and fair view.
Accounting Standards Board
(“ASB”)
The ASB is a UK standard-setting body set up in 1990 manage the use of accounting standards. Its declared aims are to ‘establish and
improve standards of financial accounting and reporting, for the benefit of users, preparers and auditors of financial information’. .
Accounting standards developed by the ASB are contained in 'Financial Reporting Standards' (FRS’s). The ASB collaborates with
accounting standard-setters from other countries and the International Accounting Standards Board (IASB) in order to ensure that its
standards are developed as far as possible to be consistent from country to country.
Accruals
Accruals are amounts that are owed to third parties for which a business has not yet been invoiced. The total of accruals is shown in the
balance sheet as part of creditors due less than one year. For example, where a business has not been invoiced by an advertising agency
for its costs for the last three months of the year, it will show in its accounts an accrual for the estimated amount of the invoice.
Accruals concept
One of the fundamental accounting concepts, the accruals concept is also known as the “matching concept”. Under the accruals concept,
revenue and costs are credited or charged to the profit and loss account for the year in which they are earned or incurred, not when any
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cash is received or paid. For example, if a sale is made on credit this year, but the cash is only received next year, the sale is treated as
income in this year. Similarly, if a business incurs a cost during the year (e.g. electricity) but is not invoiced until early in the next year, the
accounts will show an estimated liability for the expected amount of the invoice.
Acid test ratio
The “acid test ratio” (also know as the “quick ratio”) is an accounting ratio that is concerned with business liquidity. It is defined as current
assets (excluding stocks) divided by creditors falling due within one year. The acid test ratio is designed to test the short term solvency of a
business, in a way similar to the current ratio. Stocks are excluded from current assets on the basis that it can often take several months to
convert stocks into cash.
Acquisition
The term acquisition commonly refers to the take-over of one business by another. Sometimes the acquisition will involve the purchase of
the entire share capital of a company. In other situations the acquisition is off certain trading assets rather than an actual company.
Acquisitions can be financed by paying cash. Often they also involve the issue of shares by the acquiring business - given to the
shareholders of the business being sold. Acquisitions are subject to regulatory control via the competition authorities. For larger, crossborder acquisitions, regulation by authorities such as the European Competition Commission must also be taken into account.
Activity-based costing
Activity-based costing (commonly shortened to “ABC”) is a system of costing which recognises that costs are incurred by each activity that
takes place within a business and that products (or customers) should bear costs according to the activities they use. The use of ABC
requires the identification of “cost drivers” – those activities that take place in a business that cause costs to be incurred. The costs
associated with these cost drivers also need to be identified so that they can be appropriately allocated to each activity being costed.
Aged creditors report
Most businesses make use of an aged-creditors report to manage the timing of payment to trade creditors. The report lists the amounts
payable to trade creditors based on the payment terms agreed with them. It also lists creditors who have been owed money for the longest
period.
Aged debtors report
An aged debtors report lists amounts owed to a business by trade debtors and analyses how long the amounts have been due. The report is
a crucial piece of information for managing the amount of credit given to customers and for chasing outstanding amounts.
Agency relationship
The term “agency relationship” describes the relationship between management and shareholders. It explains how management act as
agents for shareholders, using their delegated powers to run the business in the best interests of the shareholders
Administration
Administration is a term used to describe a situation relating to the possible insolvency of a business. Under an “Administration Order”, a
court supervises the affairs of a company in financial difficulties with to the aim of securing its survival as a going concern or, failing that, to
achieving a more favourable realisation of its assets than would be possible on liquidation. While the administration order is in force, the
affairs of the company are managed by an “administrator”.
Allotment of shares
When new shares are issued in a company it may be that there is excess demand for the shares. In such a case, shares are “allotted” to
new subscribers on a fair basis – although almost always in lower numbers than were requested. The process of share allotment is a
common feature of new share issues on the London Stock Exchange.
Alternative Investment Market
The Alternative Investment Market (usually shortened to “AIM”) is a junior market of the main London Stock Exchange. AIM replaced the
Unlisted Securities Market in 1995. It provides an opportunity for smaller companies with growth prospects to raise capital and have their
shares traded in a market without the expense of a full market listing.
Amortisation
Amortisation is a term used to describe the reduction in value of an asset through wear or obsolescence. In relation to tangible fixed assets,
amortisation is mode commonly known as “depreciation”. In the UK, amortisation usually refers to the reduction in value of intangible assets
such as acquired goodwill.
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Annual general meeting
The annual general meeting (“AGM”) is an annual meeting of the shareholders of a company, which must be held every year. The usual
business transacted at an AGM is the presentation of the audited accounts, the appointment of directors and auditors, the fixing of their
remuneration, and recommendations for the payment of dividends. Other business may be transacted if notice of it has been given to the
shareholders.
Annual report & accounts
All limited companies are required by UK company law (the Companies Act) to prepare an annual report each year, containing their financial
statements, directors’ report and, for larger companies, the auditor’s report. The annual report of a listed business (i.e. a business quoted on
a public stock exchange) must also contain a five year summary of results together with a wide range of other financial and operating
disclosures). The annual report and accounts must be sent to shareholders and to the Registrar of Companies – the government department
that maintains the public records of companies. Once sent to the Registrar, the annual report becomes a public document, available for
anyone to view.
Annuity
An annuity is a constant annual payment. The guarantee of the maintenance of such annual payments is also known as an annuity, and can
usually be purchased from insurance companies. A certain’ annuity is paid over a specified number of years, whereas a life’ annuity is paid
until the death of the named recipient. An annuity may be bought with a lump sum or through a series of contributions.
Arbitrage
Arbitrage refers to the exploitation of differences between the prices of financial assets or currency or a commodity within or between
markets by buying where prices are low and selling where they are higher. For example, if coffee is cheaper in New York than in London
after allowing for transport and dealing costs, it will pay to buy in New York and sell in London. If interest rates are higher on a Euro deposit
in London than in Frankfurt, a higher return will be obtained by switching funds from one centre to the other. Unlike speculation, arbitrage
does not normally involve significant risks, since the buying and selling operations are carried out more or less simultaneously and the profit
made does not depend upon taking a view on future price changes. By eliminating price differentials, arbitrage contributes to the
achievement of market equilibrium.
Articles of Association
The Articles of Association (the “Articles”) is the official company document that acts as a contract between a business and its shareholders.
The Articles describe the rights and duties of the shareholders with the business and between themselves (see also Memorandum of
Association)
Asset
An asset is defined by Financial Reporting Standard Number 5 as “a right or other access to future economic benefits controlled by an entity
as a result of past transactions or events”. Future economic benefits might simply mean the conversion of the asset into cash (e.g. payment
of cash received from a trade debtor). By contrast, a “fixed asset” describes ownership of an asset that can be used in the long-term to
create value for a business (see also current assets, fixed assets, intangible assets).
Asset turnover
Asset turnover is an accounting ratio. It measures the productivity of the assets of a business achieved by comparing asset values with
sales revenue. For example, “fixed asset turnover” could be calculated by dividing the net book value of fixed assets by sales.
Audit
An audit can be defined as “a systematic examination of the activities and status of an entity, based primarily on investigation and analysis of
its systems, controls and records” . The Accounting Standards Board defines the annual audit that is required by most UK limited companies
as an independent examination of, and expression of an opinion on, the financial statements of the enterprise”. Not all companies require an
audit – there are exemptions available for small companies provided that they meet certain criteria.
Audit report
All companies above a certain size are required to have their financial statements audited by a registered auditor. The auditor prepares an
“audit report” (which is presented at the front of the financial statements) stating whether or not the financial statements give a “true and fair
view of the business’s results and financial position”. In most cases the audit report given is “clean” – in other words there are no problems
reported to shareholders. However, audit reports can also be “qualified”. In qualifying an audit report, the auditor draws the attention of the
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user of the financial statements to matters which are material and which should be considered when reading the accounts. For example, the
auditor may be concerned about the ability of the company to continue on a going concern – in which case the audit report would be
qualified on a “going concern” basis.
Audit trail
The audit trail is the range of documents and other evidence which records all the activities and transactions of a business. Such a historic
record allows the firm to piece together the chronology of a transaction. It is also required for compliance purposes. The audit trail is of
particular importance to the auditor who is required to obtain evidence that transactions are correctly recorded and reported by a business.
Auditing Practices Board
(“APB”)
The Auditing Practices Board (“APB”) (formed in 1991) is responsible for developing and issuing professional standards for auditors in the
United Kingdom and the Republic of Ireland.
Auditor
An auditor is a professionally qualified accountant who is appointed by, and reports independently to, the shareholders. The auditor provides
an independent opinion to shareholders and other users that the financial statements have been prepared properly and in accordance with
legislative and regulatory requirements; that they present the information truthfully and fairly, and that they conform to the best accounting
practice in their treatment of the various measurements and valuations (see audit and audit report)
Authorised share capital
The authorised share capital of a company is the maximum amount of share capital that may be issued by a company. This amount can be
found by looking in the company's memorandum of association. The authorised share capital must be disclosed on the face of the balance
sheet or alternatively in the notes to the accounts. This is also referred to as “nominal share capital”.
Average cost
Average cost represents the average cost per unit of output. It is calculated by dividing total costs, both fixed costs and variable costs, by the
total units of output. For example, if total costs are £250,000 (comprising fixed costs of £150,000 and variable costs of £100,000) and total
output units are 10,000; then the average cost is £25
Bad debt
A bad debt is a debt owed to a business that is not expected to be received. This may arise, for example, as a result of the insolvency of a
customer who had been buying products on a credit basis. Bad debts are written off either as a charge to the profit and loss account or
against an existing doubtful debt provision.
Balance sheet
The balance sheet provides a statement of a business’s financial position at a given point in time. It details the assets of the business and
how these assets are being financed. Financing is broken down into two major categories - shareholders' funds and liabilities. Due to the
way in which the balance sheet is prepared, total assets will always equal total finance, i.e. the balance sheet will balance.
Balanced scorecard
The “balanced scorecard” is a popular approach to the analysis and reporting of management information. It emphasises the need to
provide the user with a set of information which addresses all relevant areas of performance in a way that is objective and unbiased. The
information contained in the balanced scorecard usually includes both financial and non-financial elements, and covers areas such as
profitability, customer satisfaction, internal efficiency, innovation and quality.
Banking covenants
Banking covenants are a crucial part of any bank loan agreement. A loan agreement in the form of a covenant will include a series of
undertakings, the breaching of which will make the loan repayable immediately. The breaching of an undertaking will also be an event of
default. In this situation, the bank assumes much greater financial control over the business (for example, it can prevent the payment of any
dividends).
Batch costing
A form of costing in which the unit costs are expressed on the basis of a batch produced
Bookkeeping
Bookkeeping is the process of recording monetary transactions in the financial records of a business. Originally, bookkeeping was a timeconsuming manual process. However, it is now largely mechanised through the wide-range of bookkeeping software programmes. (See
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double-entry bookkeeping)
Breakeven
Breakeven refers to the quantity of output or value of sales necessary to cover fixed costs.
Breakeven chart
A breakeven chart is a graph on which a business' total costs, analysed into fixed costs and variable costs, are drawn over a given range of
activity, together with the sales revenue for the same range of activity. The point at which the sales-revenue curve crosses the total-cost
curve is known as the breakeven point (expressed either as sales revenue or production/sales volume). The breakeven chart, like breakeven
analysis, may also be used to determine the profit or loss likely to arise from any given level of production or sales, the impact on profitability
of changes in the fixed or variable costs, and the levels of activity required to generate a required profit.
Budget
A budget is a quantified financial statement that covers a defined period of time. A budget will normally include planned sales costs assets,
liabilities and associated cash flows.
Budgetary control
Budgetary control is the way in which financial control is maintained within a business - by using budgets for income and expenditure for
each main function of the business. During the course of a financial period, these budgets are compared with actual performance to
establish any variances. Individual managers who are responsible for the controllable activities within their budgets are expected to take
corrective action on adverse variances (e.g. where costs are greater than budget or where sales or income are less than budget)
Business angel
Business angels are wealthy entrepreneurs who provide capital in return for being part of a growing successful business. For businesses
requiring funds of up to £500,000, business angels are important sources of finance. A business angel will usually expect hands-on
involvement with the businesses into which he or she invests.
Business angel network
A Business Angel Network (BAN) is a group of business angels, who are wealthy individuals looking for investment opportunities in
businesses, and businesses seeking finance.
Business entity concept
The concept that financial accounting and reporting relates to the activities of a specific business entity and not to the activities of the owners
of that entity.
Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) was introduced on 1 January 1994 with the aim of encouraging new equity investment in trading
companies by providing generous tax incentives to investors other than those already connected with the company. An investor may qualify
for both income tax relief and capital gains tax relief in respect of an EIS investment. The capital gains tax relief in particular can be
extremely valuable, as it can mean that the large gain that may potentially be made by investors in high tech companies when they realise
their investment, may be exempt from taxation.
Business plan
A detailed plan setting out the objectives of a business over a stated period usually 1-5 years. A business plan is drawn up by many
businesses. For new businesses it is an essential document for raising capital or loans. The plan should quantify as many of the objectives
as possible, providing monthly cash flows and production figures for at least the first two years. It must also outline its strategy and the
tactics it intends to use in achieving its objectives. For a group of companies the business plan is often called a corporate plan.
Call option
A call option gives the holder of the option the right to buy a share (or other asset) at the exercise price at some future time. (See also put
option)
Capital allowances
A tax allowance for businesses on capital expenditure on particular items. These include machinery and plant, industrial buildings,
agricultural buildings, mines and oil wells, and scientific equipment.
Capital employed
Capital employed is essentially the underlying asset base a business needs to generate its profits and turnover. It is usually defined as fixed
assets plus working capital, although alternative definitions are possible. It can also be calculated by adding together shareholders' funds
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and long-term liabilities. Having calculated capital employed, it is possible to assess the level of return that this investment is producing by
using an accounting ratio such as “return on capital employed”.
Capital expenditure
Capital expenditure is that expenditure by a business that results in the acquisition of fixed assets or an improvement in their earning
capacity. Capital expenditure is not charged as an expense in the profit and loss account; the expenditure appears as a fixed asset in the
balance sheet. The consumption or use of the fixed asset over time is reflected in the profit and loss account by calculating the amount of
depreciation that has occurred. (See depreciation)
Capital Gains Tax (“CGT”)
CGT is a tax on capital gains. Most countries have a form of income tax under which they tax the profits from trading and a different tax to
tax substantial disposals of assets either by traders for whom the assets are not trading stock (e.g. a trader's factory) or by individuals who
do not trade (e.g. sales of shares by an investor). The latter type of tax is a capital gains tax.
Capital markets
A market in which long-term capital is raised by industry and commerce, the government, and local authorities. The money comes from
private investors, insurance companies, pension funds, and banks and is usually arranged by issuing houses and merchant banks. Stock
exchanges are also part of the capital market in that they provide a market for the shares and loan stocks that represent the capital once it
has been raised
Capital rationing
Capital rationing describes a situation in which a business has only a limited amount of capital to invest in potential projects. As a result, the
different possible investments need to be compared with one another in order to allocate the capital most effectively. This is done by
evaluating the potential returns that each investment might achieve, and allocating capital to the projects with the best projected returns.
(See also payback, net present value, investment appraisal)
Capital structure
The capital structure of a business refers to the way in which it is financed. In most cases the capital structure will comprise a combination of
long-term capital (e.g. ordinary shares, reserves, preference shares, debentures, long-term bank loans etc) and short-term liabilities (such as
a bank overdraft and trade creditors). It is important that a business is financed by an appropriate capital structure that reflects the nature of
the business and its ability to generate profits and cash flow. For example, a business at the start-up or growth stage may not be profitable
and may also have significant investment requirements. In this example, the appropriate capital structure would mainly comprise equity
finance such as ordinary shares rather than bank debt (where the business would need to finance interest charges).
Cash
Cash is an asset of a business and represents cash in hand, and deposits repayable on demand with any bank or other financial institution.
Cash flow budget
The cash flow budget summarises the expected cash inflows and the expected cash outflows of a business over a budget period. It is
usually prepared on a monthly basis, but can be for shorter or longer periods depending on the needs of management. The main purpose of
a cash flow budget is to determine when cash surpluses are likely to be available for investment or when cash deficits are likely to arise
requiring additional finance. The cash flow budget is also referred to as the “cash flow forecast”.
Cash flow statement
The cash flow statement is an historical record of the cash flows of a business, distinguishing between different categories of cash receipts
and payments. Financial Reporting Standard FRS 1 (Cash flow statements) requires most companies to publish a cash flow statement as
part of their annual accounts. The purpose of this statement is to reveal to users how cash was generated and then applied by the company
during the period under review.
Charge
A term used in relation to the insolvency of a business. Charge refers to security which is taken by a creditor over property or classes of
property owned by a creditor to protect against non-payment of a debt (frequently by a mortgage or other fixed charge). The advantage of a
charge is that it places the charge-holder ahead of other creditors in the event of the debtor's insolvency.
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Companies Acts
The UK acts of parliament concerned with companies. Much of UK company law is now influenced by European legislation.
Consistency concept
The consistency concept is one of the fundamental accounting concepts that underpin the preparation of accounts. With the consistency
concept, the principle applied is that there is uniformity of accounting treatment of like items within each accounting period and from one
period to the next.
Consolidated accounts
Consolidated accounts are the financial statements of a group of companies – aggregated to show the overall financial results and position
of the group.
Contingent liability
A contingent liability is a possible liability of a business that arises from past events. The reason why the liability is “contingent” is that its
existence (and final amount) can only be by the occurrence of one or more uncertain future events not wholly within the control of the
business. For example, a business may be subject to a legal claim of some kind which may result in the business having to pay costs or
damages. The outcome of the legal claim may be uncertain – as might the possible costs arising. In this case, the business has to take a
prudent view as to the likely outcome. Where the amount and outcome of a contingent liability can be predicted with reasonable likelihood,
the “prudence” concept suggests that the business should make provision for the liability in its accounts as soon as possible. (See also
provisions, prudence concept)
Contract costing
A costing technique applied to long-term contracts in which the costs are collected by contract.
Contribution
Contribution is the amount - under marginal costing principles – of profit that has been earned before taking account of fixed costs or
expenses of a business.
Convertible securities
A convertible security is a security that, at the option of the holder, may be exchanged for another asset, generally a fixed number of shares
of common stock. Convertible issues frequently are fixed-income securities such as debentures and preferred stock.
Corporate governance
Corporate governance describes the way companies are directed and controlled. Boards of directors are responsible for the governance of
their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an
appropriate governance structure is in place.
Corporation tax
Corporation tax is the taxation payable by companies on their profits. As with other direct taxes (such as income tax) there are different
rates of corporation tax payable (depending on the level of profits achieved). Companies also receive tax allowances which they can use to
reduce the amount of corporation tax payable. The main kind of allowance – capital allowances – provides a tax incentive to invest in fixed
assets. Smaller companies also benefit from lower corporation tax rates.
Corporation tax rates
The corporation tax rate is the rate at which companies pay corporation tax. The rate varies depending on the size of the business. A small
business for tax purposes pays corporation tax, currently 20%. A small business for tax purposes is defined as a business with taxable
profits of £300,000 or less. The normal rate of corporation tax is currently 30% and is paid by companies with taxable profits of £1.5 million or
more. Companies with profits between these two limits pay corporation tax at a tapering rate between 20% and 30% [check these numbers]
Cost centre
A cost centre is a production or service location, function, activity or item of equipment for which costs are accumulated and to which they
are charged.
Creative accounting
Creative accounting is the term used to describe the deliberate manipulation of reported accounting information with the intention to mislead
users of the accounts. Creative accounting tries to take advantage of the use of subjective judgement used in preparing accounts. The
ability to use creative accounting has been significantly reduced in recent years following the issue of a range of more prescriptive and
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detailed accounting standards. (See accounting standards, window-dressing).
Creditors
Creditors form part of a business’s liabilities and represent amounts due to third parties. Creditors are analysed in the balance sheet into
those due within one year and those due after more than one year. For most businesses, the main creditor is “trade creditors” – amounts
owed to providers of goods and services on credit terms to the business. (See current liabilities)
Creditor days ratio
The creditor days’ ratio provides an indicator of the average number of days' credit taken by a business before its trade creditors are paid. It
is calculated by the following formula: (Trade creditors × 365)/annual purchases on credit.
Current liabilities
Current liabilities are those short-term liabilities which are intended to be constantly replaced in the normal course of trading activity. Current
liabilities typically comprise: trade creditors, accruals and bank overdrafts.
Current ratio
The current ratio is an accounting ratio. It is usually defined as current assets divided by creditors falling due within one year. The ratio is
designed to assess the solvency of a business in the short term. If the current ratio exceeds one, then the value of current assets is greater
than the value of the short term creditors, indicating that the business is able to pay its short term debts as they fall due. Note that this
interpretation is fairly simplistic and the resulting ratio depends on the nature of the market in which the business operates. For example,
supermarkets usually have a current ratio of less than one since they do not sell goods on credit (i.e. minimal trade debtors) yet have large
ongoing balances owed to trade creditors. The most important judgement applied to this ratio (and other similar liquidity ratios) is in
understanding the reasons for any significant deterioration in the ratio.
Debenture
A debenture is a form of loan. It is a written acknowledgement of a debt by a business that normally containing provisions as to payment of
interest and the terms of repayment of principal. A debenture may be secured on some or all of the assets of the business or its subsidiaries.
Debtor days
The debtor days ratio is an accounting ratio that provides insight into the effectiveness of working capital management. The calculation of
debtor days (average trade debtors divided by average daily sales on credit terms) indicates the average time taken, in calendar days, to
receive payment from credit customers. An increase in debtor days would suggest that credit customers are being allowed to take longer to
pay amounts due – which has adverse effects on business cash flow. (See also creditor days)
Debtors
Debtors represent amounts owed to a business by its customers and other third parties. Debtors are shown as part of current assets in the
balance sheet.
Deep discount bonds
A deep-discount bond is a long-term debt security that, because of a low coupon rate of interest compared with current rates of interest, sells
at a substantial discount from face value. Bonds of this type, if not original-issue discounts, are preferred by some investors because they
are unlikely to be called before maturity.
Depreciation
Depreciation is the name given to the amount charged to the profit and loss account to reflect the wearing out of a fixed asset over its useful
life. The purpose of depreciation is to comply with the accruals concept. Since the benefit of a fixed asset is received over several periods,
the cost of acquiring the asset is charged against profits over that period. There are several methods available to calculate depreciation.
The two most popular approaches are the “straight-line” and “reducing balance” methods. It should be noted that the depreciation charge in
the profit and loss account has no effect on the cash flows of a business. It is simply a subjective estimate of the falling value of an asset.
Depreciation provision
The depreciation provision is the amount of depreciation that has cumulatively been charged to the profit and loss account, relating to a fixed
asset, from the date of its acquisition. Fixed assets are stated in the balance sheet at their net book value (or written down value) which is
usually their historical cost less the cumulative amount of depreciation at the balance sheet date. (See also net book value)
Direct cost
A direct cost is a cost that can be directly related to producing specific goods or performing a specific service. For example, the wages of an
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employee engaged in producing a product can be attributed directly to the cost of manufacturing that product.
Director
A director is a person elected under a company’s Articles of Association to be responsible for the overall direction of the company’s affairs.
Directors usually act collectively as a board and carry out such functions as are specified in the articles of association or the Companies
Acts, but they may also act individually in an executive capacity.
Directors’ report
The Directors’ Report forms part of a company’s annual report and accounts. It is a legal requirement that the directors write a report
summarising the company’s performance over the financial period covered by the accounts, comment on the company’s future prospects,
and provide other required disclosures.
Discounted cash flow
Discounted cash flow is a method of investment appraisal. It involves the discounting of the projected net cash flows of a project to ascertain
its present value.
Discount rate
A term used in investment appraisal to refer to the “hurdle rate of interest” or cost of capital rate applied to the discount factors used in a
discounted cash flow appraisal calculation. The discount rate may be based on the cost-of-capital rate adjusted by a risk factor based on the
risk characteristics of the proposed investment in order to create a hurdle rate that the project must earn before being worthy of
consideration. Alternatively, the discount rate may be the interest rate that the funds used for the project could earn elsewhere.
Dividend cover
The dividend cover ratio is an accounting ratio that is concerned with the level of returns that are given to shareholders compared with the
ability of the company to deliver profits. The dividend cover ratio is defined as net earnings per share divided by net dividend per share. The
purpose of the ratio is to identify how much of a business’s profits are being distributed to shareholders and how much is being retained to
finance future expansion of the business. Generally a business with a low dividend cover is paying out most of its earnings as dividends and
is unlikely to achieve high growth in the future, compared to a business with high dividend cover. Dividend cover is usually only relevant to
companies that are quoted on a recognised stock exchange. It is rare that the ratio would be calculated for a private company.
Dividend policy
Dividend policy refers to the decisions made by a company as to how much profit should be distributed by way of dividends to shareholders
as opposed to being reinvested in the business
Dividends
Dividends represent amounts paid to shareholders out of the profits of a business. Dividends are usually paid annually or semi-annually,
and represent part of return on a shareholders’ investment in a business. Preference shares receive a fixed dividend while for equity shares
the level of dividend depends on the profitability of the business. Dividends are effectively declared and paid net of income tax. (see also
dividend cover)
Double entry bookkeeping
A method of recording and processing accounting transactions based upon the concept that each transaction has a dual aspect; a debit
entry and a credit entry
Doubtful debt
A doubtful debt is a debtor balance where there is some uncertainty as to whether or not it will be settled, and for which there is a possibility
that it may eventually prove to be bad. A doubtful debt provision may be created for such a debt by charging it as an expense to the profit
and loss account. (See also bad debts)
Due diligence
Due diligence is an investigation - normally conducted by an independent accountant or consultant - of the current financial and/or market
position and future prospects of a business prior to a stock exchange flotation or a major investment of capital. For example, venture
capitalist undertake extensive due diligence on potential investments before completing the deal.
Earnings per share
Earnings per share (usually shortened to “eps”) is a measure of shareholder return. It measures a business’s profitability from the point of
view of equity shareholders. It is defined as earnings attributable to equity shareholders divided by the number of equity shares in issue over
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the year.
EBITDA
EBITDA is an acronym for a calculation of a business’ profit that excludes financing costs, taxation and depreciation. It is calculated as
operating profit before interest, tax, depreciation, and amortisation.
Economic order quantity
(“EOQ”)
The economic order quantity (“EOQ”) represents the optimal ordering quantity for an item of stock which will minimise stock-holding costs.
Useful economic life
The period for which the present owner of an asset will derive economic benefits from its use.
Employee share ownership plan
(“ESOP”)
A method of providing the employees of a company with shares in the company. The ESOP buys shares in its sponsoring company, usually
with assistance from the company concerned. The shares are ultimately made available to the employees, usually directors, who satisfy
certain performance targets.
Environmental reporting
Publicly-quoted businesses in the UK are required to provide a statement included within their annual report and accounts that sets out the
environmental policies of the business and an explanation of its environmental management systems and responsibilities. The environmental
report may include reporting on the performance of the business on environmental matters in qualitative terms regarding the extent to which
it meets national and international standards. It may also include a quantitative report on the performance of the business on environmental
matters against targets, together with an assessment of the financial impact.
Equity shares
Also referred to as ordinary shares or (in the USA) common stock. Equity shares represent the right to participate in the residual assets of a
business and typically have voting rights. Equity shareholders will usually receive a dividend, the level of which depends on the level of
achieved profits and the extent to which the directors wish to reinvest profits back into the business. If the business is wound up, equity
shareholders will be entitled to any assets left over after all other investors have been paid off. Equity shareholders have limited liability,
which means that their liability to contribute money to the business is limited to the amount they have already invested.
Exceptional items
Exceptional items are separately reported in a business’s profit and loss account. Exceptional items are those which are material, derived
from events or transactions within a business’s ordinary activities and which need to be disclosed separately to ensure that the business’s
accounts give a true and fair view. (See also extraordinary items)
Export credit insurance
Export credit insurance is insurance taken out against the risk of non-payment by foreign customers for export debts.
Extraordinary items
Extraordinary items are separately disclosed in a business’s profit and loss account. Items which are material, possess a high degree of
abnormality, are not expected to recur and are derived from events or transactions outside of the ordinary activities of a business. Note that,
because the definition of ordinary activities is extremely wide, it is extremely unlikely that a business will show an extraordinary item in its
accounts in any one year. (see also exceptional items).
Factoring
Factoring describes an arrangement whereby the debts of a business are collected by a factor business, which advances a proportion of the
money it is due to collect. (See also invoice discounting).
Finance lease
A finance lease is a lease where the lessor transfers substantially all the risks and rewards of ownership of the asset to the lessee. (See also
operating leases)
Financial accounting
Financial accounting is the function responsible for the reporting required by company legislation for shareholders. It also provides such
similar information as required for Government and other interested third parties, such as potential investors, employees, lenders, suppliers,
customers, and financial analysts.
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Financial intermediary
A financial intermediary is a party that brings together providers and users of finance, either as a broker or as principal.
Financial management
Financial management is the general term that describes the management of all the processes associated with the raising and use of
financial resources in a business.
Financial Reporting Council
The Financial Reporting Council (“FRC”) is the body which provides the strategic direction behind the development of Accounting Standards
in the UK. It has two main operations - the Accounting Standards Board and the Financial Reporting Review Panel, which issue and enforce
Accounting Standards in the UK. <add links>
Financial Reporting Review
Panel
The Financial Reporting Review Panel is the body responsible for ensuring that companies in the UK follow Accounting Standards. <add
link> (See also Accounting Standards Board and Financial Reporting Council)
Financial Reporting Standards
Financial Reporting Standards (“FRSs”) are issued by the Accounting Standards Board. The use of FRSs replaced the previous form of
accounting standards in the UK which were named “Statements of Standard Accounting Practice”. (see also Accounting Standards).
Finished goods
Products that have completed the manufacturing process and are available for distribution to customers. Compare finished goods with
“work-in-progress”.
First in first out (“FIFO”)
First-in first-out is a method used to calculate the cost if stocks or inventories. It assumes that the oldest items or costs are the first to be
used. It is commonly applied to the pricing of issues of materials, based on using first the costs of the oldest materials in stock, irrespective
of the sequence in which actual material usage takes place. Closing stocks are therefore valued at relatively current costs.
Fixed assets
A fixed asset is defined as any asset, tangible or intangible, acquired for retention by an entity for the purpose of providing a service to the
business, and not held for resale in the normal course of trading. This includes, for example, equipment, machinery, furniture, fittings,
computers (see also depreciation)
Fixed charge
A fixed charge is held by the charge-holder over specific assets (typically a mortgage in respect of property) which prevents a debtor from
selling or otherwise dealing with the charged property without payment in settlement of the debt due to the charge-holder
Fixed cost
A fixed cost is one which, within certain output or turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or
turnover). A good example would be the rent and rates charge for an office, or the employment costs of staff who provide services not
directly related to production or output (e.g. the accounting department).
Forward currency transaction
A forward currency transaction is a transaction where a rate of exchange is agreed today but delivery occurs on an agreed date in the future.
The rate of exchange is known as the forward exchange rate. Forward exchange rates are mainly used as a way of creating greater
certainty about what the actual cost of a transaction will be in the local currency of the business. The use of forward currency transactions is
often referred to as “currency hedging”.
Gearing
Gearing refers to the use of debt as part of the financial structure of a business. The use of debt as a source of finance reduces the amount
of equity funding that is required. However, a business partly financed by debt needs to be satisfied that it will be able to meet the interest
payment obligations of the debt providers.
Generally accepted accounting
principles (“GAAP”)
In the UK the concept of “generally-accepted accounting principles” is taken to mean accounting standards and the requirements of
company legislation and the stock exchange.
Gearing ratio
The gearing ratio is an accounting ratio which measures the level of debt finance a business has raised relative to its level of shareholders’
funds. The gearing ratio is also known as the “debt to equity ratio”. It is usually defined as total debt divided by shareholders’ funds,
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expressed as a percentage. The precise definition will vary, however, from situation to situation. The higher the percentage from the
calculation, the more highly geared a business is. It is possible to calculate the net gearing ratio, where cash balances are deducted from
debt in the calculation. (See also interest cover and gearing)
Going concern
Going concern is one of the fundamental accounting concepts (the others being prudence, accruals and consistency). Under the going
concern concept it is assumed that a business will continue in operational existence for the foreseeable future. This assumption has
significant implications for the valuation of assets in the balance sheet – which can be stated at their net book value. If there was a doubt
about the ability of the business to operate as a going concern, then certain assets would have to be valued at their disposal value (which is
likely to be lower than net book value). (See also accounting concepts)
Goodwill
Goodwill, in the accounting sense, refers to the difference between the total value of a business and the value of its net assets in its balance
sheet. It represents the ability of the business to generate profits and cash in the future. The value of goodwill is often only determined when
a business is bought or sold. Acquired goodwill (the difference between the purchase price for a business and its net assets, is amortised
through the profit and loss account.
Gross margin
Gross margin is a profitability ratio calculated as gross profit divided by sales. The ratio focuses on the ability of the business to maintain
trading margins. (See also gross profit).
Gross profit
Gross profit is the difference between sales and the total cost of sales. (See also gross margin).
Hire purchase
Hire purchase is a method of buying goods in which the purchaser takes possession of the goods as soon as an initial instalment of the price
(a deposit) has been paid. The purchaser only obtains ownership of the goods when all the agreed number of subsequent instalments are
paid.
Historical cost concept
The historical cost concept is a basis of accounting prescribed by the Companies Act for published accounts. Under this system of
accounting, all values are based on the historical costs incurred.
Indirect cost
Indirect costs are those costs that are untraceable to particular units or cost centres. It is expenditure on labour, materials or services which
cannot be economically identified with a specific saleable cost unit. In order to determine the total cost of production on a “fully absorbed
basis) such costs have to be allocated, that is assigned to a single cost unit, cost centre, or cost account or time period.
Insolvency
Businesses are placed into insolvency when they are unable to pay creditors’ debts in full after realisation of all their assets. The decision to
place a business into insolvency is normally taken by the creditors of a business – usually a bank. There are several different forms of
insolvency – the main ones being administration, receivership and liquidation.
Interest cover
Interest cover is an accounting ratio. It measures the level of a business’s profits relative to its interest charge in the profit and loss account.
It is usually defined as profits before interest and tax divided by interest charges, but the precise definition will vary depending on the
circumstances. The higher the ratio, the less ‘gearing’ a business has. The interest cover ratio is particularly important for lenders, in that it
helps them determine the vulnerability of interest payments to a drop in profit. (See also gearing and gearing ratio)
Internal audit
Internal audit is the name given to an independent appraisal function established within a business to examine and evaluate its activities as a
service to the business. The objective of internal auditing is to assist members of the business in the effective discharge of their
responsibilities. To this end, internal auditing furnishes them with analyses, appraisals, recommendations, counsel and information
concerning the activities reviewed. (See also audit)
Internal control
An internal control is a financial or other form of management control that helps provide a business with more effective, efficient operation, or
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to enable the business to comply with laws and regulations. Many internal controls are concerned with the application of authority and
approval levels (for example, who can authorise purchases or make payments). Others are concerned with the complete and accurate
maintenance of business records. The system of internal controls is usually monitored by the internal audit function (if one exists) and is
reviewed by the auditors of a business as part of their audit of the financial statements.
Internal rate of return (“IRR”)
The internal rate of return (“IRR”) is the annual percentage return achieved by a project, at which the sum of the discounted cash inflows
over the life of the project is equal to the sum of the discounted cash outflows. A business that uses discounted cash flow techniques as a
method of investment appraisal will often use a target IRR as a discount rate in evaluating potential investments or projects.
Investment appraisal
Investment appraisal is a process whereby the likely revenues and costs generated by an investment are evaluated over the life of the
project.. Such appraisal includes the assessment of the risks of, and the sensitivity of the project's viability to, forecasting errors. The
appraisal enables a judgement to be made whether to commit resources to the project.
Invoice discounting
Invoice discounting is used by some businesses as a way of raising working capital. It involves the purchase (by the provider of the invoice
discounting service) of trade debtors at a discount to their book value. Invoice discounting enables the business from which the debts are
purchased to raise working capital by swapping trade debtors into cash. (See also invoice factoring).
Job costing
Job costing is a method of costing which identifies the individual costs of performing each job.
Last in first out (“LIFO”)
Last-in, first out (“LIFO”) is a method of valuing stocks (inventory). LIFO assumes that the last item of stock received is the first to be used.
Leasing
Leasing relates to a contract between a lessor and a lessee for hire of a specific asset selected from a manufacturer or vendor of such
assets by the lessee. The lessor has ownership of the assets. The lessee has possession of the asset on payment of specified lease rentals
over a period. (See also finance lease and operating lease)
Liabilities
Liabilities represent amounts owed by a business to the third-party providers of finance other than the equity shareholders. The main
examples of liabilities include trade creditors (suppliers who sell goods to the business on credit) and bank loans and overdrafts. Liabilities
that are due to be repaid within one year are shown in the balance sheet under the heading “Creditors due within one year. Similarly,
liabilities that are not due for more than one year are separately disclosed.
Limited liability company
A limited liability company is one in which the liability of shareholders for the company’s debts is limited to the amount paid and, if any,
unpaid on the shares taken up by them. The important point about a limited liability company is that the shareholders are protected against
claims against the company, which is treated by law as a separate legal personality.
Limiting factor
In the preparation of budgets, account should be taken of “limiting factors”. A limiting factor is a constraint which limits business activities, for
example, labour or materials which are in short supply. Budgets should bear limiting factors in mind.
Liquidation
Liquidation is the formal procedure for closing down a company or partnership including realisation and distribution of assets
Liquidator
A liquidator is the Official Receiver or an insolvency practitioner who is appointed to attend to the liquidation of a company or partnership.
Liquid resources
Liquid resources are alternative terms for the “liquid assets” of a business. These are the cash balances and other assets readily convertible
into cash, for example short-term investments.
Liquidity ratios
There are various accounting ratios that relate to the financial resources of a business. These are known as liquidity ratios. The main two
statistics are the current ratio and the acid test ratios which measure the relationship between current assets and current liabilities.
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Loan stock
Loan stock is long-term business finance on which interest is paid, usually at a fixed rate. Holders of loan stock are, therefore, long-term
creditors of a business.
Long-term capital
Capital invested or lent and borrowed for a period of five years or more
Management accounting
Management accounting is a broad term to describe the techniques used to collect, process, and present financial and quantitative data
within a business to enable effective scorekeeping, cost control, planning, pricing, and decision making to take place.
Management buy-out (“MBO”)
The acquisition of a business by its existing management. MBO’s are usually funded by venture capitalists
Marginal cost
The variable costs per unit of production. The variable costs are usually regarded as the direct costs plus the variable overheads. Marginal
cost represents the additional cost incurred as a result of the production of one additional unit of production
Marginal costing
Marginal costing is a costing method whereby each unit of output is charged with only the directly-attributable variable production costs.
Using this method, fixed production costs (such as the factory rent and rates) are not considered to be real costs of production, but costs
which provide the facilities for an accounting period that enable production to take place.
Matching concept
The matching concept is an alternative term for the “accruals concept” - one of the fundamental accounting concepts (See also accruals
concept)
Materiality
Materiality is the concept that is used to evaluate whether accounting information is sufficiently significant to users of accounts such that it
should not be omitted or misstated in the accounts. Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. The concept of materiality is particularly important for auditors who must assess whether
errors they find in accounts need to be adjusted before the accounts are finalised. (See also audit)
Memorandum of association
The Memorandum of Association is a constitutional document of a company that deals with matters such as the company name, registered
office, the fact that it has limited liability, its trading objects and other relevant facts. The other main constitutional document of a business
are the Articles of Association.
Merchant banks
Merchant banks are financing institutions that carry out a variety of financial services, including the acceptance of bills of exchange, the issue
and placing of loans and securities, portfolio and unit trust management and some banking services.
Mezzanine debt
Mezzanine debt is a kind of loan finance where there is little or no security left after the main bank loan debt has been secured. To reflect the
higher risk of mezzanine funds, the lender will charge a rate of interest of perhaps four to eight per cent over bank base rate, may take an
option to acquire some equity and may require repayment over a shorter term.
Minority interests
Minority interests arise when a company has a subsidiary company in which it does not own all of the shares. The shareholders apart from
the holding company are referred to as the minority interests. For example, where a holding company owns 80% of the shares in a
subsidiary company, the remaining 20% of shareholders are the minority interests.
Net assets
Net assets are disclosed as part of the balance sheet. Net assets equals total assets on the balance sheet less total liabilities.
Net assets per share
Net assets per share is an accounting ratio. It is defined as net assets divided by the number of shares in issue. It is also known as net
worth per share. The purpose of the ratio is to compare the net assets per share with the share price. The share price will either be at a
premium to net asset value or a discount.
Net current assets
Net current assets are disclosed as part of the balance sheet. Net current assets equal total current assets less total creditors falling due
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within one year. It is also more commonly known as working capital. When short term creditors exceed current assets, it is referred to as net
current liabilities.
Net book value
Net book value is the difference between the original purchase cost of a fixed asset less the cumulative amount of depreciation that has
been charged to the profit and loss account in relation to that asset. For example, if a piece of machinery had a purchase cost of £75,000
and depreciation of £50,000 had been charged on that asset, the net book value of the machinery in the balance sheet would be £25,000.
Net present value (“NPV”)
Net present value is the value obtained by discounting all cash outflows and inflows of a capital investment by a chosen target rate of return
or cost of capital
New issues
A new issue relates to the listing of a company’s shares onto the stock exchange for the first time
Non-executive director
A non-executive director is part of a company’s board of directors. However, the non-executive director does not have any executive
responsibility in the business. In other words, he or she does not get involved in the day-to-day management of the business. The purpose
of non-executives is to act as an independent reviewer of the activities of the executive directors and to safeguard the interests of the
shareholders.
Operating cycle
The operating cycle, or working capital cycle, is calculated by deducting creditor days from stock days plus debtor days. It represents the
period of time which elapses between the point at which cash begins to be expended on the production of a product and the collection of
cash from the customer.
Operating lease
An operating lease is a lease where the lessor retains most of the risks and rewards of ownership. (See also finance lease)
Operating margin
Operating margin is an accounting ratio that is concerned with the level of profitability. It is calculated by dividing operating profit by total
sales and expressing the result as a percentage.
Operating profit
Operating profit is the net profit that is earned by a business before any exceptional items, finance costs or tax charges. It can be calculated
by taking gross profit (or gross margin) plus/less all operating revenues and costs.
Operational gearing
Operational gearing refers to the relationship of fixed costs to total costs. The greater the proportion of fixed costs, the higher the operating
gearing, and the greater the advantage to the business of increasing sales volume. If sales drop, a business with high operating gearing may
face a problem from its high level of fixed costs.
Opportunity cost
Opportunity cost is an important concept – particularly in the context of investment or project appraisal. The opportunity cost is the value of
the benefit sacrificed when one course of action is chosen, in preference to an alternative. The opportunity cost is represented by the
forgone potential benefit from the best rejected course of action.
Options
Options are found in most areas of finance. For example, options are used in convertible shares and warrants, insurance, currency
arrangements and interest rate management. The two main types of option are call options and put options.
Ordinary shares
Ordinary shares are part of the equity finance of a business. Ordinary shares entitle the holders to the remaining divisible profits (and, in a
liquidation, the assets) after prior interests, for example creditors and prior charge capital, have been satisfied
Overdraft financing
Overdraft financing is provided when businesses make payments from their business current account exceeding the available cash
balance. An overdraft facility enables businesses to obtain short-term funding – although in theory the amount loaned is repayable on
demand by the bank.
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Overhead
An overhead is a cost that is not directly related to the production of a specific good or service but that is indirectly related to a variety of
goods or services. For example, the cost of maintaining and insuring a large factory is an indirect production cost that must be spread over a
number of products or services.
Overhead absorption rate
The overhead absorption rate provides a means of attributing overhead to a product or service, based, for example, on direct labour hours,
direct labour cost or machine hours. Overhead absorption rates are required by the full cost method of pricing products and services. (See
also marginal costing)
Overtrading
Overtrading occurs when a business expands too rapidly, putting a strain on its financial resources. This can lead to liquidity problems.
Payback
Payback is a method of investment appraisal. The payback period represents the number of years it takes the cash inflows from a capital
investment project to equal the cash outflows. A business may have a target payback period, above which projects are rejected. The main
drawback with the payback method is that it does not reflect the time-value of money. Accordingly, it does not discriminate between
receiving cash now as compared with receiving the same amount of cash in several years time. Another criticism of the payback method is
that it ignores cash flows that arise after the payback has been completed.
Post balance sheet events
Post balance sheet events are those favourable and unfavourable events, which occur between the balance sheet date and the date on
which the financial statements are approved by the board of directors. The directors must decide whether the financial statements should
either reflect post-balance sheet events or whether they simply need to be mentioned (without adjusting the accounts). An event which
might require the accounts to be adjusted would be one which provides evidence about conditions existing at the balance sheet date. For
example, the insolvency of a major trade debtor would suggest that the debtor balance at the year-end should be provided for as a bad debt.
Preference shares
Preference shares are part of the equity finance of a company. Preference shares usually receive a fixed dividend each year and which, if
redeemed, are redeemed at par value. Although the dividend is fixed, it is not guaranteed. However, if the company fails to pay ('passes') the
preference dividend for the year to ordinary shareholders. Where the preference shares are cumulative, any arrears of preference dividend
will also have to be paid prior to the ordinary dividend being paid in any year. Preference shares may be redeemable, when they will be
redeemed at a set date. They may also be convertible. Finally, they may be participating, which means that in addition to the fixed dividend,
they will receive a variable dividend dependent on the performance of the company. (See also ordinary shares)
Preferential creditor
A preferential creditor is a creditor who is entitled to receive certain payments in priority to other unsecured creditors. Such creditors include
government departments, occupational pension schemes and employees.
Prepayments
Prepayments are classified as current assets in the balance sheet. Prepayments include prepaid expenses for services not yet used, for
example rent in advance or electricity charges in advance, and also accrued income. Accrued income relates to sales of goods or services
that have occurred and have been included in the profit and loss account for the trading period but have not yet been invoiced to the
customer.
Present value
Present value is the cash equivalent now of a sum of money receivable or payable at stated future date, discounted at a specified rate of
return. (See also net present value)
Price-to-earnings ratio (“p/e
ratio”)
The price-earnings (“p/e”) ratio is an accounting ratio that is concerned with measuring the overall profitability of a business based in relation
to the equity shareholders who will share in that profit. The p/e ratio is defined as the share price divided by the earnings per share. Broadly
speaking, the higher a business’s P/E ratio, the more expensive the business and the more highly rated it is. (See also earnings per share)
Profit and loss account
The profit and loss account is one of the primary financial statements. It shows a business’s income and expenditure over a period of time,
usually one year. The term “profit and loss account” is also used in the “shareholders funds” part of the balance sheet. In this context, the
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term represents accumulated profits which a business has generated since its incorporation.
Profit before tax (“PBT”)
Profit before tax is a separate line in the profit and loss account. It is calculated by taking operating profit plus or minus net interest.
Profit centre
A profit centre is a part of the business that is accountable for both costs and revenues – the manager is responsible for revenues and costs.
Provisions
Provisions are liabilities where the business is uncertain as to the amount or timing of the expected future costs. For example, if a business
is subject to a law suit, it may provide now for the expected liability on loss of the law suit. This is an example of the prudence concept. (See
also liabilities)
Prudence
The prudence concept is one of the fundamental accounting concepts. It is important that financial statements are prepared on a prudent
basis. Revenue must not be shown in the accounts until the cash realisation of the revenue is reasonably certain. On the other hand, costs
arising as a result of past actions should be provided for immediately, even if the cash will not be paid over until the future.
Public limited company (“PLC”)
A public limited company “plc”) is a company which, by registering as a plc and adhering to strict legal requirements as a result, has the
ability to issue shares to the public. Contrast this with a Private Limited Company, which is not permitted to issue shares to the public. A
public limited company should not be confused with a Listed Company. A listed company is a public limited company which has obtained a
listing from the UK Listing Authority and not all public limited companies do this.
Put option
A put option gives the holder of the option the right to sell a share (or other asset) at the exercise price at some future time. (See also call
option)
Quick ratio
A measure of liquidity, similar to the current ratio except that stocks are excluded from the calculation of net current assets (since it may be
some time before stocks can be converted back into cash).
Ratio analysis
Ratio analysis is the study of the relationships between financial variables. Ratios of one business are often compared with the same ratios
of similar businesses or of all operators in a single industry. This comparison indicates if a particular business’ financial statistics are suspect.
Likewise, a particular ratio for a business may be evaluated over a period of time to determine if any special trend exists.
Reserves
Reserves are part of shareholders’ funds on the balance sheet. All parts of shareholders’ funds apart from share capital are reserves, such
as the share premium account, the profit and loss account and the revaluation reserve.
Residual value
The residual value of an asset is the expected proceeds from the sale of the asset, net of the costs of sale, at the end of its estimated useful
life. Residual value is used for computing the straight-line method and diminishing-balance method of depreciation, and also for inclusion in
the final year's cash inflow in a discounted cash flow appraisal.
Retained profits
Retained profits are those profits that have not been paid out as dividends to shareholders, but retained for future investment by the
company.
Return on capital employed
Return on capital employed (“ROCE”) is an accounting ratio designed to assess the profit-generating capacity of capital employed . It is
defined as profits before interest and tax divided by capital employed, expressed as a percentage. Broadly speaking, the higher the return on
capital employed, the more successful the business.
Return on equity
Return on equity (usually shortened to “ROE”) is a measure of investment return that compares the profit earned by a business with the
amount invested in the business by shareholders.
Revenue expenditure
Revenue expenditure is charged to the profit and loss account. It is expenditure that is incurred (1) for the purpose of the trade of the
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business (e.g. selling costs, administration costs) or (2) to maintain the existing earning capacity of fixed assets
Rights issue
A rights issue is an issue of shares for cash by a company to its existing shareholders on a basis pro rata to their existing shareholdings. The
rights issue will normally be at a substantial discount to the current share price (often between 20% and 40% discount).
Risk capital
An alternative term for venture capital
Sale and leaseback
The sale of a fixed asset that is then leased by the former owner from the new owner. A sale and leaseback permits a firm to withdraw its
equity in an asset without giving up use of the asset. Sale and leasebacks are popular methods of raising cash by businesses that own
property assets.
Scrip dividend
A scrip dividend is an issue of shares to an investor in lieu of a cash dividend. The value of the shares will be designed to equal the value of
the cash dividend foregone. This may be useful for investors who wish to increase their investment in a company without incurring the costs
of buying shares in the market.
Secured creditor
A secured creditor is a creditor who holds security, such as a mortgage, over a debtor's assets
Segmental reporting
The inclusion in a business’s report and accounts of analysis of turnover, profits and net assets by class of business and by geographical
segments (Companies Acts 1985/89 and SSAP 25).
Sensitivity analysis
A modelling and risk assessment technique in which changes are made to significant variables in order to determine the effect of these
changes on the planned outcome. Particular attention is thereafter paid to variables identified as being of special significance.
Share capital
Capital is the number of existing shares in the business multiplied by the nominal value of the shares.
Shareholder
A shareholder is an owner of shares in a limited company or limited partnership. A shareholder is a member of the company.
Shareholder value
Shareholder value is an approach to business valuation and management that focuses on maximising the value of a shareholder's equity
above other business objectives. Normally, shareholder value can be increased in three ways: dividend payments, appreciation in the value
of the shares, and cash repayments.
Share premium account
Part of shareholders' funds in a business’s balance sheet. Arises when shares are issued at a premium to their nominal value. For example,
if shares with a nominal value of 100p are issued at a price of 150p, the share capital of the business will increase by the nominal value of
100p per share and the share premium account will increase by 50p per share. The total of share capital plus share premium account
therefore represents the total cash raised from shareholders by the business in the past.
Short-term capital
Capital that is lent or borrowed for a period which might range from as short as overnight up to about one year
Stakeholder theory
An approach to business that incorporates all the interests of stakeholders in a business. It widens the view that a firm is responsible only to
its owners; instead it includes other interested groups, such as its employees, customers, suppliers, and the wider community, which could
be influenced by environmental issues. It thus attempts to adopt an inclusive rather than a narrow approach to business responsibility.
Standard cost
The planned unit cost of the products, components or services produced in a period. The standard cost may be determined on a number of
bases. The main uses of standard costs are in performance measurement, control, stock valuation and in the establishment of selling prices.
Stocks
Goods purchased by a business to resell on to its customers. Included as part of current assets in the business’s balance sheet. Also known
as inventories in the USA.
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Accounting and Finance Glossary 2005
Term
Description
Stock turnover
An alternative term for inventory turnover, measuring how quickly stocks are converted into finished goods and sales.
Stock valuation
Stock valuation refers to the valuation of stocks of raw material, work in progress, and finished goods. According to generally accepted
accounting practice, stocks should be valued at the lower of cost or net realisable value and the costs incurred up to the stage of production
reached.
Straight-line depreciation
A method of depreciation that charges equal amounts of depreciation to the Profit & Loss Account during the useful life of an asset.
Subsidiary business
A subsidiary business is a business which is controlled by another business, referred to as its holding business. Control is usually achieved
either by owning shares with more than 50% of the voting rights in the subsidiary, or by having the right to appoint directors to the Board who
have a majority of voting rights on the Board.
Sunk cost
Sunk costs are those costs which have already been incurred and which cannot now be recovered.
Taxable profits
Taxable profits are the profits on which a business calculates its corporation tax charge for a year. Note that the definition of taxable profits is
not the same as accounting profits before tax. The reason for this is that the business has considerable flexibility in the way it calculates its
accounting profit before tax. As a result, the Inland Revenue has different rules in some areas for the calculation of taxable profits.
True and fair view
The requirement for financial statements prepared in compliance with the Companies Act to ‘give a true and fair view’ overrides any other
requirements. Although not precisely defined in the Companies Act this is generally accepted to mean that accounts show a true and fair
view if they are unlikely to mislead a user of financial information in giving a false impression of the business.
Turnover
An alternative term for sales or revenue.
Urgent Issues Task Force
The Urgent Issues Task Force (“UITF”) is a sub-committee of the Accounting Standards Board which is set up to deal with urgent accounting
issues on an ad hoc basis. It produces “Abstracts”, which are essentially mini Accounting Standards and must be followed by companies
when preparing their accounts. (See also accounting standards).
Variable cost
Variable costs are those costs that vary in direct proportion to the volume of activity.
Variance
A variance is the difference between a planned, budgeted or standard cost and the actual cost incurred. The same comparisons may be
made for revenues.
Variance analysis
Variance analysis is a process where the financial and operational performance of a business is evaluated in terms of variances against
budgets or standards. The purpose of analysing variances is to ensure timely identification of areas for managerial action. These variances
will be either favourable variances (F) or adverse variances (A).
Venture capital
Venture Capital is a form of "risk capital". In other words, capital that is invested in a business where there is a substantial element of risk
relating to the future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the investor
requires a higher "rate of return" to compensate him for his risk. The main sources of venture capital in the UK are venture capital firms and
"business angels" - private investors.
Warrant
A warrant is a right given by a company to an investor, allowing him to subscribe for new shares at a future date at a fixed, pre-determined
price (the “exercise” price)
Weighted average cost of
capital (“WACC”)
The weighted average cost of capital (“WACC”) is the average cost of the business’s finance. This is calculated by applying a weighting to
the different costs of finance according to the relative size of each element in the financial structure of a business.
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Accounting and Finance Glossary 2005
Term
Description
Window dressing
Window dressing is a creative accounting practice in which changes in short-term funding have the effect of disguising or improving the
reported liquidity position of the business.
Work in progress
Work-in-progress is a term used to describe products or services which are in the process of completion.
Working capital
Working capital is also known as net current assets. It is the capital available for conducting day-to-day operations of a business. Normally
working capital will be positive – i.e. there is an excess of current assets over current liabilities – which therefore needs to be funded.
Working capital cycle
The working capital cycle is another term for the cash operating cycle. It refers to the period of time which elapses between the point at
which cash begins to be spent on the production of a product and the collection of cash from a customer.
Zero-based budgeting
Zero-based budgeting is a method of producing a budget which ignores what has happened in the past. Instead, each element of the budget
is built up from a new set of assumptions. This process is inevitably more time-consuming but is often used where previous budgets in a
business have proved significantly different from actual results.
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