You are on page 1of 27


ACCELERATED DEPRECIATION An accounting method that recognizes higher amounts of depreciation in the early years of a fixed asset's life and lower amounts in later years ACCOUNT A systematic grouping that illustrates the effect of transactions and other events an particular balance sheet or income statement items. ACCOUNTING CHANGE A change in any of three areas: 1) Accounting principles such as a new method of depreciation 2) Accounting estimates such as the useful life of an asset 3) A different reporting entity, such as a merger or takeover ACCOUNTING EQUATION An equation that states that assets equals liabilities + shareholders' equity. A = L + SE The equation must always hold because assets represent the historical value of what the company owns, and liabilities and equity represent the claims on these assets. The company is responsible for the liabilities to the creditors first and then the equity of the owners. Therefore, equity is the residual or balancing factor in the difference between assets and liabilities. That is: SE = A L Seen in this way the balance sheet must always "balance" because the value of shareholders equity will change depending on the difference between assets and liabilities. ACCOUNTING PERIOD statements The length of time covered by a business's financial

ACCOUNTING RATE OF RETURN (ARR) Net income/investment. Called accounting rate of return by financial analysts because income is calculated using generally accepted accounting principles. This can be compared to various measures of "cash flow" rate of return whereby cash and not accounting profit is used as the firms payoff from an investment. ACCOUNTS PAYABLE An obligation to pay for goods or services that have been purchased on credit from suppliers. This is a current liability in a firms balance sheet. ACCOUNTS RECEIVABLE The amount owed to a company from customers who purchased goods or services on credit.

GLOSSARY ACCOUNTS RECEIVABLE TURNOVER A ratio showing the average amount of time that a company holds its receivables before collecting them. Usually, companies use a related term called "Days Outstanding" (DSO). Accounts Receivable Turnover = Revenue Average Accounts Receivable ACCRUAL ACCOUNTING The accounting method that recognizes revenue when it is earned, without regard to when the cash is collected, and recognizes expenses when they are incurred, regardless of when cash is paid to meet these obligations. ACCRUED EXPENSE Those expenses incurred, but not yet paid, at the end of an accounting period; also called accrued liabilities. Example: A company purchases $25,000 worth of office supplies on credit on December 29 and its accounting period ends on December 31. It shows the $25,000 as an accrued expense on the balance sheet for the year. ACCUMULATED DEPRECIATION particular asset The total depreciation to date on a

ACID TEST RATIO (Also called quick ratio) A test of a companys ability to pay its current liabilities. A ratio of 1+ is considered "safe." Acid Test Ratio = Cash + Marketable Securities + Accounts Receivable Current Liabilities

ADDITIONAL PAID-IN CAPITAL (Also called Paid-in Capital) The excess amount over par value that shareholders pay for a company's stock. The amount a company pays to buy back its stock from the open market (called treasury stock) is treated as a reduction to additional paid-in capital. ALLOWANCE FOR BAD DEBTS A provision a company makes for uncollectible accounts receivable. Example: Accounts receivable Less: allowance for bad debts Net receivables $150,000 15,000 $135,000

Note: If there is any unusual decrease in the average percentage of a company's receivable deemed to be uncollectible (e.g. in the case above it is 10%), a company may be trying to inflate its accounts receivables

GLOSSARY AMORTIZATION The process of allocating the portion of an intangible asset's value (e.g. patents or goodwill) that has been consumed during the current period against revenues. Similar to a companys depreciation of tangible assets. GAAP states that the amortization of an intangible asset cannot exceed 40 years and that it must be done on a straight- line basis.

GLOSSARY ANNUAL REPORT A detailed statement that a company prepares at the end of its reporting year; the reporting year can be either on a calendar or fiscal basis. This report contains a company's income statement, balance sheet, statement of cash flows, statement of shareholders' equity, management's discussion and analysis of operations, notes to the financial statements, and audit opinion. The Financial Accounting Standards Board (FASB) also requires that companies include in their annual reports operations in different industries, export sales, foreign operations, major customers, and government contracts. ASSET An economic resource of a company. Assets include money, land, buildings, property, and property rights and machinery. Tangible: Assets that can be seen or felt. Intangible: Assets that have no physical substance (e.g. patents and goodwill) Characteristics: 1) Must provide future economic benefits that can be reasonably estimated. 2) Must be controlled by its owner. 3) Must be the result of a previous event or transaction (e.g. the purchase of a new machine). Current: Assets that have future benefits that will be realized in one year or less. Non-current (fixed or other): Assets that have future benefits that will be realized in more than one year. ASSET TURNOVER (Also called Total Asset Turnover) A ratio that measures the productivity of a company's total assets. (Also called a measure of activity or efficiency). Asset Turnover = Revenue Average Assets BALANCE SHEET A statement representing a company's financial position at a specific date, usually at the end of an accounting period; also called a "statement of financial position." BEGINNING INVENTORY The merchandise on hand at the beginning of an accounting period. Beginning inventory is frequently used in calculating cost of goods sold on an income statement. BOOK VALUE

GLOSSARY (1) The amount shown for an asset on a balance sheet. For fixed and other assets, it is based on historic cost or the amount that was paid for the asset when it was purchased. For example, the "book value" of a machine is its initial cost less its accumulated depreciation. (2) The amount shown as a company's stockholders' equity on a balance sheet. Seen in this way, the book value of a company is the value of its "net worth" (assets less liabilities).

GLOSSARY BOOK VALUE PER SHARE shareholders. The assets of a company made available to its

Book Value per Share Total Stockholders = Equity Average Shares Outstanding BREAKEVEN ANALYSIS (Also called Profit-Volume-Cost Analysis) The calculation of the point at which sales revenue equals total cost of production. Breakeven Volume = Total Fixed Cost Price - Average Variable Cost CAPITAL Unless preceded by the term "working" (see Working Capital) this is the amount an the balance sheet that represents The long term commitment of funds in a company; long-term debt and shareholders' equity. Note: If the term "share capital" is used, it refers only to the value of the shares originally purchased by the owners. This, along with accumulated retained earnings, is part of shareholders equity. CAPITAL STOCK The shares representing the ownership of a company. Issued capital stock that remains in the hands of stockholders is categorized as "outstanding." Stock that is repurchased by the management is called "treasury stock. " CAPITAL STRUCTURE The proportion of debt and equity that are being used to fund 'the companys investment in its assets. A company that uses relatively more debt than equity is said to have a more highly "leveraged" capital structure. (See "Leverage.") CASH FLOW The cash receipts less the cash disbursements from a given operation or asset for a particular period of time. There are a number of different measures of this term, depending on what cash disbursements are taken into account for the particular time period. A clarification of these different terms is best done using a "Statement of Cash Flows," provided in a company's annual report. Here are a few examples: "Basic Cash Flow" Net income + depreciation (often a quick and easy method for estimating a company's operating cash flow, particularly for companies that have large fixed asset investments). "Cash Flow From Operations" Net income + depreciation and amortization + or -- changes in non-financial working capital (a measure of cash flow now

GLOSSARY required to be shown in all companies annual reports in their statement of cash flows). "Free Cash Flow" Cash Flow From Operations less Capital Expenditures and Dividends (a measure of cash flow that indicates how much cash a company has generated in a given accounting period after meeting its operating and major financial requirements).

GLOSSARY CERTIFIED PUBLIC ACCOUNTANT (CPA) A title given to accountants who pass the Uniform CPA Examination administered by the American Institute of Certified Public Accountants and who satisfy the experience requirements of a give state. CPAs are licensed to issue an audit opinion on a company's financial statements. CONSERVATISM One of the basic accounting tenets under generally accepted accounting principles (GAAP). It states that a company must recognize all losses as soon as they are quantifiable but cannot record gains until they realized. CONSOLIDATION The reporting of both a parent company and its subsidiaries as a single entity. A company is considered a subsidiary if another company owns more than 50 percent of its voting common stock. (Also see "minority interest.") CONTROLLER (Also called Comptroller) The principal accounting executive for a company. The controller's duties include 1) 2) 3) 4) 5) 6) Financial reporting and interpretation Tax administration Accounting system development Internal and external audit coordination Internal controls management Cost analysis.

The controller (along with the treasurer) usually reports directly to a company's Chief Financial Officer. CONTRIBUTION MARGIN (CM) The amount by which a company's sales revenue exceeds the variable cost of its production or service. Used to help determine the breakeven point of a firms operations. (See "Breakeven Analysis.") This term is used in cost accounting. A similar, but not equal term used in financial accounting is "gross profit margin." COST ACCOUNTING A method of accounting for the costs of operating a business by allocating these costs to the goods a company produces or the services it renders. The methods of cost allocation are determined by the company for its internal use. They do not have to follow GAAP, the standard that companies must follow for Financial Accounting for external reporting purposes. COST CENTER A unit such as a department, piece of equipment, process, or individual within a company to which direct costs can be attributed. In addition to direct costs, many cost centers are also assigned a portion of the companys overhead or fixed costs.

GLOSSARY COST OF GOODS SOLD (Also called COST OF SALES) Typically abbreviated as COGS, this is the cost of producing, converting or buying an item that the firm subsequently sells. When subtracted from sales revenue, it shows the amount of a firm's gross profit. Revenue - Cost of goods sold Gross Profit CURRENT ASSET Any asset shown on a firm's balance sheet that has a useful economic life of one year or less. It can also be considered an cash or any item that the company believes will become cash within the one year period. This includes short-term marketable securities, accounts receivable, inventory, and prepaid expenses. CURRENT LIABILITY A debt that is payable within one year (based on the date shown on its balance sheet). Typical current liabilities include accounts payable, short-term notes payable, and the current portion of a firm's longterm debt. CURRENT RATIO obligations. A measure of a company's ability to meet its short-term Current ratio = Current Assets Current Liabilities Short-term lenders such as banks generally consider a ratio of 2.0 to be quite adequate. DAYS INVENTORY A measure of the number of days it takes to sell the average amount of inventory on hand during a particular period of time. As a rule, the longer it takes to sell inventory, the greater the risk of not being able to sell it at full value. Also, if a firms days inventory starts to increase, it may indicate a drain on its cash flow. Days Inventory = 365 days Inventory Turnover Ratio Cost of Goods Sold Average Inventory on Hand

Inventory Turnover Ratio =


Example: If a company has an Inventory turnover of 5.25 days, its day inventory would be 365/5.25 or 69.5. DEBT-TO-EQUITY RATIO This is one of the common measures of the degree of leverage used by the firm to finance its assets. Often the book value of a company's debt and equity are used to compute this figure. A ratio higher than 1.0 generally indicates a fairly high degree of leverage is being used.


GLOSSARY DEFERRED INCOME TAX LIABILITY An estimation of the amount of future taxes on income that has been earned and recognized for accounting purposes but not yet recognized for tax purposes. This is shown as a long-term liability on the firm's balance sheet. The reason for this item is due to the difference in the method of depreciation of a firm's assets for financial reporting purposes and for tax purposes. Generally, companies use straight-line depreciation for their financial reports and some type of accelerated depreciation such as the sum-of-the-years digits for tax purposes. Example: Suppose a company's revenue minus all expenses except for taxes is $50,000 (let us call this "income"). Based on the two methods of depreciation and using a 40% tax rate, we see the following. Book Income* $50,000 $5,000 $45,000 Taxable Income $50,000 $7,500 $42,500 $18,00 0 $17,00 0 $1,000

Income Depreciation Income before taxes Tax expense Tax payable

($45,000 X40%) ($42,500 X40%)

Deferred income tax liability *This is the amount shown in the annual report.

DEPRECIATION An accounting method of spreading the cost of a fixed asset, such as plant and equipment, over its useful life. The basic concept behind depreciation is that the value of every asset is reduced through use or obsolescence. Through depreciation, a relationship is established between the asset's ability to generate revenue and the reduction of its value. This relationship is in accordance to the "matching principle." The three methods of depreciation are: 1) Straight line 2) Sum-of-the-years' digits 3) Double declining balance. In addition to deciding on the method to use, a company must also determine the estimated expected useful life of the asset and the assets salvage value. The higher the rate of depreciation used, the lower the company's accounting income that is reported in its financial statement. However, higher rates of


GLOSSARY depreciation could have a positive impact on a firm's cash flow by reducing its tax obligations at an earlier rather than later time in the life of the fixed assets. DISCOUNTED CASH FLOW A method used to reduce a forecasted stream of cash flows to its present value. The amount of the reduction is based on a company's cost of capital. This method is the basis for a company's capital budgeting or long-term cash allocation decisions. DIVIDEND The distribution of a company's earnings to stockholders. Cash dividends are most common, although dividends can be issued in other forms such as stock or property. DIVIDEND PAYOUT RATIO The measure of the percentage of earnings paid in dividends. The ratio is usually calculated by dividing dividends per share by earnings per share. Example: A company has net earnings of $200,000, pays a dividend of $50,000 and has 50,000 common shares outstanding. Earnings per share is then $4 and dividends per share is $1. The dividend payout ratio is: $1 = 4 .25 or 25%

DOUBLE DECLINING BALANCE DEPRECIATION A method of accelerated depreciation in which 200 percent of the straight-line depreciation is applied to the declining balance of the asset's book value. Example: An asset is worth $1000 and has a useful life of 5 years. The straightline depreciation rate would call for a 20 percent reduction over the 5 years. Therefore, the double declining method would use a 20 percent reduction. This increases the amount depreciated in the earlier years of the life of the asset, but reduces it in the later years. Example: An asset is worth $1000, has a useful life of 5 years, and has a straight-line depreciation of 20%. Therefore, double declining balance would use a rate of 40% (20% X 200%). The annual depreciation charges would be calculated as follows: Yea r 1 2 3 4 5 Original Cost $1000 $1000 $1000 $1000 $1000 Beg. Book Value $1,000.00 $600.00 $360.00 $216.00 $129.60 60 x x x x x Double Dec. Rate 40% 40% 40% 40% 40% = = = = = Depreciati on $400.00 $240.00 $144.00 $86.40 $51.84



The process usually continues until the depreciated expense becomes inconsequential or the asset is sold. Sometimes companies switch to the straight-line method to complete the depreciation. EARNINGS PER SHARE (EPS) A measure of a company's profit shown in terms of each share of common stock. EPS = Net Income - Preferred Dividend Average Common Stock Outstanding


GLOSSARY EQUITY (Also called stockholders Equity or owners' Equity) The monetary value that represents ownership interest in a business. The two most important components of equity are: 1) 2) 1) 2) Capital stock Accumulated retained profit. Treasury stock Foreign exchange translation adjustments

Two other items often listed are

Because accountants define equity as equal to assets minus liabilities, equity is also referred to as the net worth of a company. (See "Book Value.") EXTRAORDINARY ITEM An item in a company's financial report that is both unusual and infrequent. Extraordinary gains and losses are reported on a company's income statement between entries for income from discontinued operations and the cumulative effect of a change in accounting principle. Examples of these items include: 1) 2) 3) 4) 5) Write-off of an intangible asset Gains on life or property insurance Restructuring charges Natural disasters such as earthquakes or floods Gains or losses from early retirement of debt

Note: Write-off and write-down of inventories and receivables are not considered extraordinary because they are related to normal business activities. FINANCIAL ACCOUNTING An accounting method that records, interprets, and reports the historical cost transactions of a company. Publicly held companies must follow financial accounting principles laid down by the Financial Accounting Standards Board (FASB) and the American institute of Certified Public Accountants (AICPA). Together, these principles are referred to as "Generally Accepted Accounting Principles (GAAP). The Securities and Exchange Commission (SEC) is ultimately responsible for establishing financial reporting standards for publicly owned companies, yet it lets the FASB and AICPA set up the ground rules. FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) The Independent institution that establishes and disseminates generally accepted accounting principles and recording practices. FINANCIAL STATEMENTS A report containing financial information about a company. The three financial statements found in an annual report are: 1. Balance sheet 2. Income statement, and

GLOSSARY 3. Statement of cash flows


GLOSSARY FINISHED GOODS INVENTORY The amount of goods on hand that can be sold to customers. It is listed as a current asset on the balance sheet and is used to calculate cost of goods sold in the income statement. It can be contrasted to work-in-process inventory and raw material inventory. FIRST-IN FIRST-OUT (FIFO) A method of inventory valuation based on the concept that merchandise is sold in the order of its receipt. For example, if an electronics store buys 100 stereos in January and 50 in February, FIFO assumes that the units purchased in January will be sold before the units purchased in February. FIFO shows current inventory costs on the balance sheet and, by using lower historical costs for costs of goods sold (assuming rising prices of products), maximizes net income on the income statement. (Remember, the lower the cost of goods sold, the higher the profit, other costs and expenses held constant.) FIFO and LIFO are both permitted for income tax calculations, although once a company chooses a method, it cannot change it without permission from the IRS. If a company chooses LIFO for tax purposes, it must also use LIFO in its published financial statements. FIXED ASSET An item purchased for the operation of a business that has physical substance and a useful economic life greater than one year and is not to be sold to customers. FIXED COST Charges that stay constant regardless of increases or decreases in business activity. Current costs and inventory figures that are based on older, historic costs. This leads to lower net income than would have resulted from FIFO. FOREIGN CURRENCY ADJUSTMENT The process of converting the functional currency of a foreign subsidiary company, branch, representative office, or other affiliated entity into U.S. dollars for financial statement presentation. The "transactions effect" reflects changes in the dollar value of a foreign currency, denominated receivable, or current liability (e.g. incurred as a result of importing or exporting). Gains or losses resulting from foreign exchange fluctuations are reported on the income statement. The "translation effect" reflects changes in the value of a foreign subsidiary's assets or liabilities. These changes are shown as adjustments to the parent companys equity. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) The policies, standards, and rules followed by accountants in the preparation of financial statements.



GOING PUBLIC The sale of a portion of a privately held company's common shares in the public as a means of raising equity capital. The first time a company sells stock to the public, this issue is called an "Initial Public Offering" or IPO.


GLOSSARY GOODWILL The value of intangible assets, such as reputation, name recognition, and customer relations, that give a company an advantage over competitors. Goodwill appears in a company's financial statements only if it has been paid for in a business combination using the "purchase method." In this case, the value of the goodwill is the difference between the purchase price of the company and the book value of its assets. The amortization of goodwill can be done over a period of not more than 40 years. It is shown on the firm's financial statement but is not tax deductible. GROSS PROFIT (Also called Gross Margin) The excess of revenue over cost of goods sold. When it is expressed as a percentage of revenue it is usually called gross profit margin. INCOME STATEMENT (Also called Profit and Loss statement or "P&L) A formal statement of the elements used in determining a companys net income. There is no uniform method of presenting an income statement in an annual report. However a typical statement could look like this: Revenue (also Sales, Next Sales, or Sales Revenue) Cost of Goods Sold GROSS PROFIT Selling, general, administrative expenses (S,G&A) Research and Development OPERATING INCOME (Profit) + other income Other expenses such as interest INCOME BEFORE TAXES Provision for income taxes INCOME FROM CONTINUING OPERATIONS + or extraordinary items + or cumulative effect of change in accounting principle NET INCOME INTERNAL RATE OF RETURN (IRR) The discount rate at which the net present value of all future cash flows equals zero. This rate is often used to determine the financial desirability of a long-term investment. If the IRR is greater than the firm's cost of capital (the opportunity cost of its money), then the project is considered to be economically justified. INVENTORY Any goods available for resale at any given time. It is recorded at the lower of cost or market value and reported on the balance sheet. The three types of inventory in manufacturing are: 1. Raw materials


GLOSSARY 2. Work-in-process 3. Finished goods


GLOSSARY INVENTORY TURNOVER A measure of the number of times that the average amount of inventory on hand is sold within a given period of time. Inventory Turnover Ratio = Cost of Goods Sold Average inventory on hand Sometimes sales revenue is used instead of cost of goods sold. LAST-IN, FIRST-OUT (LIFO) A method of inventory valuation based on the concept that merchandise is sold in the reverse order of its receipt or production. In periods of inflation, LIFO results in cost of goods figures that are based on the most recent current costs, and inventory figures that are based on older historic costs. This leads to lower net income than would have resulted from FIFO. LEVERAGE The amount of debt relative to equity used by a company to finance the purchase of its assets. A higher leverage results in a higher return on equity, assuming a given amount of profit. However, greater leverage increases the interest payments of a company and increases its risk relative to these debt obligations. Typical ways to measure leverage are: Leverage Ratio = Debt Ratio = Total Assets Equity Debt Debt + Equity

LEVERAGED BUYOUT (LBO) The purchase of controlling interest in a company using debt collateralized by the target company's assets to fund most or all of the purchase price. LIABILITY An obligation payable in money, services, or goods. Liabilities are reported on the balance sheet and include accounts payable, accrued expenses, and debt. MANAGEMENTS DISCUSSION AND ANALYSIS OF OPERATIONS A Section in an annual report, required by the Securities and Exchange Commission, that summarizes the reasons for changes in operations, liquidity, capital resources, and working capital of a company. The section is designed to help readers of financial statements understand the effects of changes in business activity and accounting.


GLOSSARY MARKET TO BOOK RATIO An indicator of the degree to which the management of a company has been able to increase the value of shareholder investment. The higher the ratio, the better. At a minimum, this ratio should be greater than 1.0. If not, shareholders could consider the company from a financial standpoint to be better off "dead than alive." Market to Book Ratio = Market Value Book Value Market Value = price of a share of stock Book Value (per share) = equity/shares outstanding MARKETABLE SECURITY An equity or debt security that is easily converted into cash. Examples include traded stocks, commercial paper, and treasury bills. They are reported at their cost as a current asset on the balance sheet. MATCHING CONCEPT One of the basic accounting tenets. This concept mandates that expenses must be recorded in the same accounting period that the benefits, usually sales, are derived. This principle underlies the entire system of accrual accounting. MATERIALITY The relative importance of an accounting error or omission in a company's financial statements. If an item is deemed to be material, it must be disclosed in a company's financial report. MERGER A combination of two or more companies. This combination may be accomplished by: 1) The exchange of stock for stock, which results in the combining of accounts (called a "tax-free pooling of interests). 2) By forming a new company to acquire the assets of the combined companies (called a consolidation). 3) By a purchase, where the amount that is paid in excess of the acquired company's book value (and that cannot be allocated to the acquired assets) is treated as goodwill on the books of the purchaser. Although consolidations and statutory consolidations are technically not mergers, the terms are commonly used interchangeably. MINORITY INTEREST An ownership interest of less than 50 percent. In consolidated financial statements, it is shown as a line item in noncurrent liability on the balance sheet. NET INCOME (Also called net profit, net after-tax profit, net income after taxes) The result of subtracting all expenses from revenue.


GLOSSARY NET PRESENT VALUE (NPV) The present value of the future cash to be received from an investment in excess of the cost of the investment. An NPV greater than zero indicates an economically justified investment opportunity. NOTE PAYABLE A contract to pay a creditor at a future date. Reported on the balance sheet either as a current or noncurrent liability, depending on when the principal is due. OFF-BALANCE SHEET ITEM An item not reported on financial statements that nevertheless has an impact on the operations of a company. Examples include liabilities such as pending litigation or guarantees of future performance.


GLOSSARY ORIGINAL EQUIPMENT MANUFACTURER (OEM) The original producer of a product as distinguished from any other element in the distribution channel. For example, JVC might have an OEM arrangement with Kodak by selling them blank video tapes which are then marketed under the Kodak label. PAID-IN CAPITAL See Additional Paid-in Capital.

PAR VALUE The face value of a security such as common stock. The par value is usually some arbitrary amount established more for convenience than for any economic reason. (e.g. $1.00 or $.10) PRICE-EARNINGS RATIO (P-E Ratio) A commonly used measure of a company's investment potential. This ratio depends on investors' perceptions of a company's potential. Factors such as risk, quality of management, growth potential, earnings history, and industry conditions all come into play. P-E Ratio = Price per Share Earnings per Share

P-E Ratios in the high teens and twenties generally indicate that investors are very optimistic about the company's earnings potential. PROFIT MARGIN A measure of a firm's profit-earning ability relative to its dollar volume of sales. The type of profit margin depends on which measure of profit is being used. Gross Profit Margin = Operating Profit Margin = Net Profit Margin = Gross Profit Revenue Operating Profit Revenue Net Profit Revenue

Generally, the higher the gross profit margin, the greater the chances of a firm having a high operating and net profit margin. 40% is typical of manufacturers, 25% is typical of supermarkets and low-and retailers, 45% is typical of highend retailers, 80% is typical of software companies. Manufacturers typically end up with around a 5% net profit margin, while successful software companies (such as Microsoft) have net margins over 20%.


GLOSSARY QUALITY OF EARNINGS An assessment of the extent to which a company's net profit is sustainable in the future. Financial ratios such as earnings per share, current ratio, and inventory ratio are all used by analysts to make this assessment. Qualitative measures, such as management strength and the firm's stated strategic plan, are also used.


GLOSSARY REALIZED GAIN OR LOSS The difference between the book value of an asset and the amount received from its sale. Realized gains or losses are reported on the income statement. Occasionally a company can report a realized loss even when there has been no sale. For example, when a longterm investment permanently declines in value, the value of the investment should be written down an the balance sheet, and the amount of the decline in value should be reported as a realized loss on the income statement. (For example, in the late 1980s AT&T wrote off a huge portion of its fixed asset investment in copper wire and analog switches (old telecommunications technology). RETAINED EARNINGS (Also called accumulated retained earnings or profit, or reinvested earnings, income, or profit.) These are the total earnings of a company, less dividends, since its inception. This is a major portion of a company's equity shown on its balance sheet. RUN RATE A term often used in budget analysis in reference to projected costs based on past expenditures. The benchmark used for past expenditures varies among companies. Some firms simply use the previous month. Others may take the average of previous months (e.g. past 3 months, 6 months etc.). For example, if the previous three months expenditures are 10, 12 and 12, then the run rate is 11.33. RETURN ON INVESTMENT (ROI) A measure of the productivity of a firms assets. There are three commonly used versions of this measure. Return on Assets (ROA) = Net Profit Average Total Assets Net Profit Average Equity Net Profit Average Debt + Equity REVENUE (Also called sales and sales revenue) Gross income received by a company before any deductions for expenses, discounts, returns, etc. SUM-OF-THE-YEARS' DIGITS (SYD) METHOD OF DEPRECIATION A method of accelerated depreciated depreciation that assigns the numbers (1,2,3,. .n) where n is the estimated useful life of an asset. Thus:

Return on Equity (ROB) = Return on Capital Employed (ROCE) =


GLOSSARY SYD = n(n + 1) 2 Remaining Useful Life SYD

The annual depreciation charges are then calculated by (Cost of the asset - Salvage Value) x

Example: An asset costs $1000, has an estimated useful life of five years, and a salvage value of $100. The SYD is calculated as 5(5 + 1) 2 The calculation of depreciation would then be as follows: Yea r 1 2 3 4 5 Cost -Salvage $900 $900 $900 $900 $900 X X X X X Remaining Useful Life/SYD 5/15 4/15 3/15 2/15 1/15 = = = = = Depreciati on $300 $240 $180 $120 $60 $900 = 15

TREASURY STOCK Shares of common stock that have been issued to the general public but have been repurchased by the company. It serves to reduce a companys total equity. TURNOVER RATIO A measure of activity of any asset such as inventory, receivables, fixed assets or total assets. WORKING CAPITAL A measure of a company's ability to service its shortterm financial obligations. It is defined as current assets minus current liabilities. WRITE-DOWN A reduction in the book value of an asset. For example, if a portion of a company's inventory were to become obsolete, the total value of the inventory would have to be written down. WRITE-OFF The reduction of the entire value of an asset as either an expense or a loss. For example, if a company's uninsured warehouse is


GLOSSARY destroyed in a fire, the warehouse would have to be written off as a loss or expense.