Financial Terms Glossary

by John Kind

Financial Terms Glossary: A – B

A

ABSORPTION COSTING

A system of costing. Products and services need to absorb a share of indirect costs, for example, insurance and rent in addition to their direct costs such as labour and raw materials.

A direct cost can be specifically allocated to a product or service. Indirect or overhead costs such as insurance and rent cannot be directly attributed to a product or service. Nevertheless, they do need to be ‘absorbed’ or included in arriving at the total cost of a product or service. Accountants use a variety of ‘absorption’ costing methods.

 

ACID-TEST RATIO

A measure of the ability of a business to meet its short-term commitments.

The ratio is calculated by dividing current assets, excluding stocks or inventories, by current liabilities. Stocks such as raw materials and finished goods are excluded because it will be some time before they can be sold and the cash received from the sale.

Current assets include accounts receivable or trade debtors (amounts due from customers) and cash balances. Current liabilities include amounts due to suppliers, bank overdrafts and unpaid expenses such as utility and telephone bills as well as VAT.

The ‘acid’ test is whether or not an organisation can pay off all its current or short term liabilities within 12 months. A general benchmark is an ‘acid’ test ratio of one. This means that there are likely to be sufficient short term assets to pay off short term liabilities.

The ‘acid-test’ ratio may be referred to as the ‘quick’ ratio.

 

ACCOUNTS PAYABLE

The American term for trade creditors; amounts due to suppliers.

 

ACCOUNTING STANDARDS

Accounting rules and guidelines covering how and what financial information should be presented to external stakeholders such as bankers and investors. These rules include, for example, the ways in which balance sheets and cash flow statements should be prepared and how taxation should be calculated in a financial period.

 

ACCOUNTS RECEIVABLE

The American term for trade debtors; amounts due from customers at a particular date.

 

ACCRUALS AND ACCRUED CHARGES

Accruals and accrued charges are items such as rent, salaries and utility costs that have been included in a financial period’s income statement or profit and loss account but have not all been paid in cash during the period. The accrual or the accrued charge is the amount unpaid at the end of the period.

 

ACCRUALS CONCEPT

Under the accruals concept, revenues or sales or turnover are recognised in the accounting period when goods and services are provided not when the cash is received for providing those goods and services.

The terms revenues, sales or turnover all have the same meaning. It is the value of the goods and services provided or the value of the work completed for customers in an accounting period.

Similarly, all the costs incurred to generate revenues are recognised in the period to which they relate irrespective of whether they have been paid for in cash.

Revenues are, therefore, matched against all the costs incurred to produce a profit or loss for the period.

There are several different measures of ‘profit’, for example, gross profit and operating profit.

 

ACTIVITY BASED COSTING

A technique for charging an indirect cost such as the cost of the procurement or purchasing function to a product or service.

The factors affecting the level of an indirect cost are called cost ‘drivers’, for example, the number of purchase orders and the number of invoices received from suppliers. These cost drivers will affect the cost of a product or service. Calculations will be made so that their impact will be included in calculating the ‘activity based’ cost.

 

ACCUMULATED DEPRECIATION/AMORTISATION

The total depreciation or amortisation deducted from a fixed or non-current asset since the date it was purchased.

 

AMORTISATION

A reduction in debt by regular payments covering both interest charges and the original amount borrowed; the principal.

The term is also used for reducing the value of intangible fixed or non-current assets such as a lease or intellectual property. This reduction in value is a cost which will be included in the income statement or profit and loss account.

 

ANNUAL REPORT AND ACCOUNTS

A report issued annually to shareholders and stakeholders such as banks, employees, customers and suppliers. It contains:

  • A profile of the organisation
  • The chairperson’s statement
  • A review of the organisation’s activities, usually by the Chief Executive
  • A statement of corporate responsibility covering, for example, health and safety and community matters
  • A statement of the principal risks facing the organisation, for example, the failure of information technology and the failure to win new contracts
  • A financial review
  • The directors’ report
  • A statement of corporate governance
  • A statement from the Audit and Risk Committee
  • A remuneration report
  • The independent auditor’s report
  • The financial statements
  • Notes to the financial statements

 

ASSETS

Everything that a company or organisation owns or that is due to it.

Cash, stocks or inventories and accounts receivable or trade debtors are examples of current assets.

Buildings, equipment, land and machinery are examples of tangible fixed or non-current assets.

Goodwill, leases and intellectual property such as patents are examples of intangible fixed or non-current assets.

 

ASSET TURNOVER

A performance measure used to assess the effectiveness with which an organisation uses its assets. It is calculated by dividing sales, revenue or turnover by capital employed. The higher the figure the better. It is difficult to give a benchmark because asset turnover varies significantly from industry to industry. For capital intensive organisations like oil exploration companies and airports, asset turnover may be below 1. For retailers and supermarkets, asset turnover may be greater than 1.

 

AUDIT

The annual inspection of a company’s financial records and its financial statements by an independent firm of external auditors. These external auditors report to shareholders in the case of a business and to members in the case of ‘not for profit’ organisations.

 

AUDITORS

Independent external accountants appointed by a company’s shareholders or an organisation’s members. Auditors are appointed by an organisation’s directors or trustees subject to approval by shareholders or members at the Annual General Meeting.

 

AUDIT COMMITTEE

A sub-committee of the board of directors of an organisation. It is responsible for monitoring all the reporting, accounting, control and financial aspects of management’s activities.

 

AUDIT REPORT

A report on the ‘truth and fairness’ of financial statements. It is addressed to shareholders of a company or the members of an organisation and prepared by the external auditors.

 

AUTHORISED SHARE CAPITAL

The total number of shares the directors of a company have been authorised or empowered by shareholders to issue.

 

B

BALANCE SHEET

A statement of the financial position of an organisation at a particular date showing the various categories of assets and how those assets have been financed.

Assets (what an organisation owns) are financed by liabilities. Liabilities are amounts owed by an organisation to third parties such as banks and suppliers plus the funding provided by and attributable to shareholders or members.

Assets must always be equal to liabilities in view of the conventions of double-entry bookkeeping.

 

BOND

An interest bearing liability.

 

BOOK VALUE

The accounting value of an asset as recorded in the financial statements. For a non-current or fixed asset it will be the original cost (unless amended by revaluation) less the depreciation or amortisation that has so far been accumulated on it. This is called the net book value or written down value.

The net book value of an asset is unlikely to be the same as the market value of an asset. The exception may be property whose value in the financial statements may approximate to market value.

 

BREAK-EVEN POINT

The level of activity or output at which total revenues, sales or turnover equals total costs.

 

BUDGET

An annual business or organisational plan covering:

A budget is a commitment to achieve a set of financial and non-financial results during a 12 month period.

 

BUDGETARY CONTROL

A short term planning system designed to ensure that the actual results achieved during the financial year are measured against the budgeted results. The differences or variances are then investigated and corrective actions are taken to ensure that, for the period as a whole, actual performance is as close to the budget as possible.