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 +
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 The length of time covered by a business's financial statements
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 firm’s 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 firm’s balance sheet.
ACCOUNTS RECEIVABLE The amount owed to a company from customers who purchased
goods or services on credit.
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 The total depreciation to date on a particular asset
ACID TEST RATIO (Also called quick ratio) A test of a company’s ability to pay its current
liabilities. A ratio of 1+ is considered "safe."
Acid Test Cash + Marketable Securities + Accounts Receivable
Ratio = 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
ALLOWANCE FOR BAD DEBTS A provision a company makes for uncollectible accounts
Example: Accounts receivable $150,000
Less: allowance for bad debts 15,000
Net receivables $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
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 company’s 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.
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)
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
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
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
(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).
BOOK VALUE PER SHARE The assets of a company made available to its shareholders.
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
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
company’s 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 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).
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) Financial reporting and interpretation
2) Tax administration
3) Accounting system development
4) Internal and external audit coordination
5) Internal controls management
6) Cost analysis.
The controller (along with the treasurer) usually reports directly to a company's Chief Financial
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
firm’s 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
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 company’s overhead or fixed costs.
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.
- Cost of goods sold
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 long-term debt.
CURRENT RATIO A measure of a company's ability to meet its short-term obligations.
Current ratio = Current Assets
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 firm’s days inventory starts to
increase, it may indicate a drain on its cash flow.
Days Inventory = 365 days
Inventory Turnover Ratio
Inventory Turnover Ratio = Cost of Goods Sold
Average Inventory on Hand
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
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-year’s 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* Taxable Income
Income $50,000 $50,000
Depreciation $5,000 $7,500
Income before taxes $45,000 $42,500
Tax expense ($45,000 X40%) $18,000
Tax payable ($42,500 X40%) $17,000
Deferred income tax liability $1,000
*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 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 = .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 straight-line 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:
Year Original Cost Beg. Book Value Double Dec. Rate Depreciation
1 $1000 $1,000.00 x 40% = $400.00
2 $1000 $600.00 x 40% = $240.00
3 $1000 $360.00 x 40% = $144.00
4 $1000 $216.00 x 40% = $86.40
5 $1000 $129.60 60 x 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
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) Capital stock
2) Accumulated retained profit.
Two other items often listed are
1) Treasury stock
2) Foreign exchange translation adjustments
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) Write-off of an intangible asset
2) Gains on life or property insurance
3) Restructuring charges
4) Natural disasters such as earthquakes or floods
5) 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
3. Statement of cash flows
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
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 company’s 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.
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 company’s net income. There is no uniform method of
presenting an income statement in an annual report. However a typical statement could look like
Revenue (also Sales, Next Sales, or Sales Revenue) -
— Cost of Goods Sold
— 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
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
1. Raw materials
3. Finished goods
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
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 = Total Assets
Debt Ratio = 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.
MANAGEMENT’S 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.
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
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
MERGER A combination of two or more companies. This combination may be accomplished
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
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
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.
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.
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 = Gross Profit
Operating Profit Margin = Operating Profit
Net Profit Margin = Net Profit
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 high-end 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%.
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.
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 long-term 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
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 firm’s assets. There are
three commonly used versions of this measure.
Return on Assets (ROA) = Net Profit
Average Total Assets
Return on Equity (ROB) = Net Profit
Return on Capital Employed (ROCE) = 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.
SYD = n(n + 1)
The annual depreciation charges are then calculated by
(Cost of the asset - Salvage Value) x Remaining Useful Life
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) = 15
The calculation of depreciation would then be as follows:
Year Cost -Salvage Remaining Useful Life/SYD Depreciation
1 $900 X 5/15 = $300
2 $900 X 4/15 = $240
3 $900 X 3/15 = $180
4 $900 X 2/15 = $120
5 $900 X 1/15 = $60
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 company’s 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 short-term 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
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 destroyed in a fire, the warehouse would have to
be written off as a loss or expense.