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14 November 2014

Business Terms for Beginners

Not sure what your Accountant or Business Advisor is telling you, than maybe this list of business terms will assist.  Some terms will require further understanding particularly if you are new to business or accounting.

You can alway come and see a business advisor at the Adelaide Hills Business Centre to provide greater understanding.  Click here to make a time.

List of business Terms . . . . .



Term Definition
Accounts payable (Creditors) A current liability that is the amount owed by your business to another party as the result of the purchase of goods, services or future benefits.

e.g. Purchase of goods on 30 days terms

Accrued expense An expense incurred but unpaid at balance date

Accumulated depreciation The total depreciation expense charged against revenues since the asset being depreciated was acquired.
It is shown in the balance sheet as an offset against the asset to which it relates.

Regardless of the method used to calculate it, the depreciation of an asset during a single period is added to the previous period's accumulated depreciation to get the current accumulated depreciation.

e.g.
Machinery Asset purchased on 01/07/2009 for $500,000 with 5 year effective life.
2009/10 depreciation ($200,000) {using diminishing value method}
2010/11 depreciation ($120,000) Accumulated depreciation = $320,000
2011/12 depreciation ($72,197) Accumulated depreciation = $392,197

Aged creditors listing A list of creditors (i.e. suppliers) to whom you owe money, categorised according to the period outstanding (for example, 0-30 days, 31-60 days).

Aged debtors listing A list of debtors (i.e. customers) whom owe you money, categorised according to the period outstanding (for example, 0-30 days, 31-60 days).

All other expense Any valid expense item not shown in one of the specific expense categories

Amortisation The deduction of capital expenses over a specific period of time (usually over the asset's life). More specifically, this method measures the consumption of the value of intangible assets, such as a patent or a copyright.

e.g.
You spend $100,000 on obtaining a copyright, which is valid for 10 years.
Each year for 10 years, you claim $10,000 as an amortisation expense.

Amortisation/Depreciation Amortisation: The deduction of capital expenses over a specific period of time (usually over the asset's life). More specifically, this method measures the consumption of the value of intangible assets, such as a patent or a copyright.

Depreciation: The gradual write-off of the cost of a non-current asset over its effective life. It is recorded as an expense in each accounting period in which the asset is used.

Amortisation example: You spend $100,000 on obtaining a copyright,which is valid for 10 years. Each year for 10 years, you claim $10,000 as an amortisation expense.

Depreciation example: You purchase machinery with an effective life of 8 years for $500,000. You calculate the decline in value of the machinery using either diminishing value or prime cost method, and deduct the calculated amount from your taxable income in each year of use. See "Guide to Depreciating Assets" http://www.ato.gov.au/content/00313557.htm for details.

Asset An asset is anything of value (e.g. An object, a right or claim, or a resource) owned by your business, or money that is owed to your business.

Bad debt expense Debts owed to your business which become uncollectable.
These are losses to your business and are written-off (as an expense against revenue) in the period when you recognise them as being uncollectable.
Bad debt is usually a product of the debtor going into bankruptcy/ liquidation, or where the additional cost of pursuing the debt is more than the amount the creditor could collect.

Balance Sheet The balance sheet, also known as the statement of financial position, lists:
  • assets
  • liabilities
  • equity
These three sections indicate what your business owns and owes, as well as the amount invested by the shareholders. It summarizes your business' assets, liabilities and shareholders' equity at a specific point in time.

Bank overdraft A credit facility which allows you to draw down funds up to an agreed credit limit.

Cash at bank All cash that you have deposited with a bank.
If the amount is negative, it is called an overdraft.

If your amount of 'Cash at bank' is below zero (an overdraft) - report the amount as a liabilty in 'Short term overdraft/Interest bearing loan' category.

Cash flow forecast/projections A cash flow projection involves forecasting your expected receipts and expenditure into the future.
It is simply looking ahead at what revenues are coming in, comparing them to when expenses and payments are due and making arrangements so the balance remains positive.

Cash flow statement/projections A statement of cash receipts (inflows) and expenditure (outflows) for a set period.

A cash flow projection involves forecasting these receipts and expenditure into the future. Cash flow projection is simply looking ahead at what revenues are coming in, comparing them to when expenses and payments are due and making arrangements so the balance remains positive.

Closing stock/inventory The value of your stock on hand at the end of an accounting period, which is verified by a stocktake.

Contingent liabilities The liabilities of your business that are uncertain in both amount and existence, and which will only be realised upon a particular event or transaction.

A good example of a contingent liability would be an outstanding lawsuit.

Cost of goods sold Your cost of producing goods up to the point of them being ready for sale.
The cost includes: materials, labour used directly in producing the goods, and the direct overhead expenses for production.

Cost of sales Your cost of producing goods up to the point of them being ready for sale.
The cost includes: materials, labour used directly in producing the goods, and the overhead expenses for production.

Creditor Any entity (person or institution) that extends you credit, giving you permission to pay back at a later date.

Creditors (Accounts payable) A current liability that is the amount owed by your business to another party (usually suppliers) as the result of the purchase of goods, services or future benefits.

Creditors ageing Creditors (i.e. Suppliers) to whom you owe money, categorised according to the period outstanding (for example, 0-30 days, 31-60 days).

Current assets Cash, or assets likely to be converted into cash within the next accounting period (< 12 Months), or assets whose benefit will not extend beyond the next accounting period.

Examples include debtors, cash and stock on hand.

Current liabilities Debts that will be due for payment within the next accounting period (less than twelve months).

Examples include a bank overdraft, creditors, short-term loans, accrued expenses and income tax payable.

Current ratio Current assets divided by current liabilities.

Current ratio identifies that for every $1 of current liabilities there are $X of current assets.
It indicates your business' ability to pay its short-term liabilities (debt and payables) with current, short-term assets (cash, stock on hand, and accounts receivable).

The higher your current ratio, the more capable your business is of paying its obligations.

A ratio less than 1 indicates that your business may be unable to pay its obligations if they fell due at that time.

e.g.
Current Assets = $600,000
Divided by
Current Liabilities = $500,000
Current Ratio = 1.2 (600 divided by 500 = 1.2)

Debt service coverage ratio (DSCR) The ratio of cash available for debt servicing, to debt payments.

A business with a DSCR of less than 1.15 will usually generate insufficient income to meet its debt commitments.

A DSCR between 1.15 - 1.35 is acceptable, above 1.35 is desirable.

e.g.
Total Monthly Repayment Capacity = $25,000
Divided by
Other Monthly Debt Commitments = $12,700
DSCR (Debt Service Coverage Ratio) = 1.97

Debtor A company or individual who owes you money.

Debtors (Accounts receivable) A current asset that is the amount owing to your business by other parties (customers) as the result of the sale of goods, services or assets.

Debtors Ageing A list of debtors (i.e. Customers) whom owe you money, categorised according to the period outstanding (for example, 0-30 days, 31-60 days).

Depreciation The gradual write-off of the cost of a non-current asset over its effective life. It is recorded as an expense in each accounting period in which the asset is used.

e.g.
You purchase machinery with an effective life of 8 years for $500,000. You calculate the decline in value of the machinery using either diminishing value or prime cost method, and deduct the calculated amount from your taxable income in each year of use.
See "Guide to Depreciating Assets" http://www.ato.gov.au/content/00313557.htm for details.

Depreciation / Amortisation Depreciation: The gradual write-off of the cost of a non-current asset over its effective life. It is recorded as an expense in each accounting period in which the asset is used.

Amortisation: The deduction of capital expenses over a specific period of time (usually over the asset's life). More specifically, this method measures the consumption of the value of intangible assets, such as a patent or a copyright.

Depreciation example: You purchase machinery with an effective life of 8 years for $500,000. You calculate the decline in value of the machinery using either diminishing value or prime cost method, and deduct the calculated amount from your taxable income in each year of use.
See "Guide to Depreciating Assets" http://www.ato.gov.au/content/00313557.htm for details.

Amortisation example: You spend $100,000 on obtaining a copyright, which is valid for 10 years.
Each year for 10 years, you claim $10,000 as an amortisation expense.

Doubtful debts An estimate of the amount of debts owed to you, that may not be collectable, and may become bad debts.

Drawings The amount of assets (usually in cash) taken out of the business by the proprietor for personal use.

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation.
(Essentially your net income, plus your interest, taxes, depreciation, and amortisation expenses added back.)
EBITDA is a key indicator of your business' repayment capacity.

It shows your business' historical cash flow and capacity to meet its financial obligations.
In general the higher the EBITDA, the greater your business' capacity to service its debts as and when they fall due.

Negative EBITDA can contribute to working capital stress.
It also indicates that the business is failing to successfully manage sales and costs from its ordinary activities.
If the business has recorded a negative EBITDA, this is a relatively strong indicator of underperformance/ financial stress.

Calculation: EBITDA = Revenue - Expenses (excluding tax, interest, depreciation and amortisation)

EBITDA as a percentage of sales Sometimes referred to as "EBITDA margin".

Measures the dollar EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) margin as a percentage of sales for a period.

EBITDA margin indicates the percentage of a business' sales revenue after its operating expenses.

If your business has a positive EBITDA it may be small as a % of sales and/ or declining - potential leading indicators of financial stress.

A higher percentage reflects a business' ability to earn revenue, whilst keeping expenses low - a measure of efficiency.

If this margin is too narrow, there is a greater risk that an increase in expenses, or a fall in revenue will eliminate any positive cashflow.

Calculation: EBITDA (%) = EBITDA ($) divided by ('Total Sales')

e.g.
If your business' EBITDA is $400,000 and your revenue is $5 Million, then your EBITDA to sales ratio is 8%.

Equity The business owner's claims on the assets of the business.
The extent to which the owners have financed the assets of the business.
Equity is always equal to the net asset/liability position.

Expense The monetary costs that your business incurs through its operations to earn revenue.
i.e. Money spent or costs incurred that are tax-deductible and reduce taxable income.

Examples of expenses include payments to suppliers, employee wages, factory leases and depreciation.

Gross margin Gross margin is the difference between sales revenue and the cost of goods sold.

Calculation: Total Sales - Cost of Goods Sold = Gross Margin ($)

Insolvent Where a person or company is unable to pay their debts as, and when the fall due.
Interest expense The interest in relation to any debt obligations, paid within a given period.

e.g.
The interest portion of business loan repayments, or interest charges incurred for late payment of taxation amounts

Inventories Stock on hand, or goods available for sale.

Investments When included on a balance sheet, investments include shares, government and other marketable securities.

Leased assets The payment of a fee for the use of an asset for a specific period of time, whereby the asset is rented rather than actually owned by a business.

e.g. Vehicle or equipment leases.

Liabilities Debts or amounts that your business owes.
Liabilities are the claims of creditors against the assets of your business.

Examples include loans, accounts payable, mortgages, deferred revenues and accrued expenses.

Liquidation/Windup The operation of putting an end to the carrying on of a business or a company, realising the assets and discharging the liabilities of the concern, settling any questions of account or contributions between the members, and dividing the surplus assets (if any) among the members.

Long term interest bearing loan A loan that has an extended time for repayment, usually 3 - 10 years.
Miscellaneous assets On a Balance Sheet, these assets do not form part of the working assets of the business. For example, loans to employees, purchases by staff and miscellaneous debtors.
Net asset/(liability)position Your net asset position is calculated by subtracting your total assets from your total liabilities (the resulting figure is also equivalent to shareholders equity).
A net asset position is when total assets exceed total liabilities and a net liability position is when total liabilities exceed total assets.

If a business records a net asset position this is an indicator of the overall strength of the business' balance sheet.
A net liability position or a net asset position that is not underpinned by quality assets is a possible indication of financial stress.

Calculation: Net Assets = Total Assets - Total Liabilities

Net loss When business expenses exceed its income.
The result that occurs when expenses exceed the income or total revenue produced for a given period of time.

Net profit When business income exceeds expenses.
A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity.

Non current assets Those assets that are expected to be used in the business for more than one year, or assets not expected to be turned into cash during the next accounting period.

Examples include property, plant and equipment and motor vehicles.

Non current liabilities Debts that are not due for payment within the next twelve months.

An example is a mortgage over the business premises.

Operating profit (after income tax) The difference between operating profit before income tax and the income tax expense.

Operating profit (before income tax) The difference between gross profit and operating expenses (including selling and administration expenses).

Other Any item which belongs in a category which doesn't have its own specific listing within that category.

Other debt commitments Total monthly repayment amount for all debt commitments including your bank overdraft and any loan facilities.

Examples include term loans, bank bill facilities, hire purchase, lease agreements.

Other income The portion of your business' income that is derived from activities not related to its core operations.

Examples include interest or dividends on investments and profit from selling investments or part of the business.

Overdraft facility A credit facility which allows you to draw down funds (in excess of your account balance) up to an agreed credit limit.

Prepaid expenses An amount that you have paid against future expenses.
It is a current asset that arises on a balance sheet as a result of business making payments for goods and services to be received in the near future.
Prepaid expenses are recorded as assets.

Profit/Loss statement The Profit and Loss Statement, also known as the Statement of Financial Performance will show:
  • income
  • sales
  • gross profit
  • expenses
  • other income (for example from asset sales)
  • net profit/loss

This is a summary of business incomes and expenses from all activities.
It also shows the net profit or loss for a specific accounting period, usually a financial year.

Profit/Loss before income tax The difference between gross profit and operating expenses including sales and administration expenses.

Property, plant and equipment A company asset that is vital to business operations but cannot be easily liquidated. The value of property, plant and equipment is typically depreciated over the estimated life of the asset, because even the longest-term assets become obsolete or useless after a period of time.

Provision for future expenditure Setting aside of liability amounts to be met at some future point in time.

e.g. Setting aside amounts for future maintenance, or for future replacement of plant and equipment.

Provision for bad debt An account that records the portion of your business' receivables, which you have determined are not collectable.

Provisions for doubtful debt An account that records the portion of your business' receivables, which you expect may not be collectable.

Quick asset Current assets that can be quickly converted to cash at close to their book values. Includes cash and receivables.

Quick ratio The degree to which your business' current obligations are covered by the most liquid current assets.
Quick Ratio is calculated by dividing your Current Assets (excluding inventories) by your Current Liabilities.

A quick ratio less than 0.5 indicates a dependency on stock to liquidate short term debt and/or that your business does not have significant liquid assets available to fund short term liabilities.

Calculation: Quick ratio equals current assets (less inventories), divided by current liabilities.
e.g.
Current assets ($600,000)
Less Inventories ($200,000) = $400,000
Divided by Current liabilities ($500,000)
Quick ratio = 0.8

Related party payables Amounts payable by your business by related parties who are connected by a pre-existing relationship.

e.g. Debt owed by a parent company to a subsidiary company, or amounts payable to the company's owners, management, or family members.

Related party receivables Amounts payable to your business by related parties who are connected by a pre-existing relationship.

e.g. Debt owed to a parent company by a subsidiary company, or amounts payable by the company's owners, management, or family members.

Revenue The amount of money that you receive during a specific period.

Includes income from all sources including investments.

Sales revenue Items include sale of goods and services.

Short term interest bearing loan A short term withdrawal of money in excess of the balance on a bank or building-society account, which creates a financial obligation on which interest is paid.

Solvency The ability to pay all of your debts as, and when they become due and payable.

Statement of financial performance The Statement of financial performance, also known as the profit and loss Statement will show:
  • income
  • sales
  • gross profit
  • expenses
  • other income (for example from asset sales)
  • net profit/loss

This is a summary of business incomes and expenses from all activities.
It shows the net profit or loss for a specific accounting period, usually a financial year.

Statement of financial position The Statement of financial position also known as a balance street, lists:
  • assets
  • liabilities
  • equity

It summarizes a company's assets, liabilities and shareholders' equity at a specific point in time.
These three sections indicate what the company owns and owes, as well as the amount invested by the shareholders.

Term Loan A loan from a bank or other financial institution for a specific amount, over a fixed term, which has specified fixed repayment amounts which include both a principal and interest component.

Total creditors The total of amounts owed by your business to suppliers.

Total current assets The total of all current assets.

Total current liabilities The total of all current liabilities.

Total debtors Total of amount owed to you by your customers who have purchased your goods/ services on credit.

Total expenses Calculated by adding all expense categories.

Total non current assets The total of all non current assets.

Total non current liabilities The total of all non current liabilities.

Trade creditors and other payables Trade creditors: Amounts owed to suppliers by your business.

Other payables: Amounts owed by your business to entities other than suppliers.

Trade receivables The accounts owed by your business' customers are called trade receivables.

Trial balance A list of debt or credit balances on a particular date to check the accuracy of the ledger recording.

Wages and salary These payments could include any of the following:
  • Salary, wages, allowances and leave loading paid to employees;
  • Director fees;
  • Payments made to workers under a labour hire arrangement;
  • Employment termination payments;
  • Payments for unused annual or long service leave.
Windup / Liquidation The operation of putting an end to the carrying on of a business or a company, releasing the assets and discharging the liabilities of the concern, settling any questions of account or contributions between the members, and dividing the surplus assets (if any) among the members.

Working capital The current assets minus the current liabilities.

Working capital indicates the operating liquidity available to a business, measuring short term assets that are available to fund short term liabilities.

e.g.
Current Assets ($600,000)
Less Current Liabilities ($500,000)
Working Capital = $100,000

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