Financial Terms Glossary

by John Kind

Financial Terms Glossary: G –L

G

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

Generally Accepted Accounting Principles. These principles represent the conventions, rules and standards used by accountants in the preparation of financial statements. Examples are:

  • Consistency – when an organisation has decided on a method for the accounting treatment of an item, it will deal with all similar items in exactly the same way. For example, using a ‘straight line’ depreciation rate of 20 per cent for office equipment.
  • Prudence – being conservative by only including a sale in the income statement when it is certain.

 

GEARING

See the debt-equity ratio.

 

GOING CONCERN

The assumption on which the financial statements of an organisation are prepared and audited. It means that the organisation is deemed to be financially viable and can meet its commitments for the foreseeable future.

If auditors mention that ‘going concern’ is questionable then the organisation concerned may not be financially viable. This might be the case, for example, when it is difficult to renew borrowing facilities.

Specific reference to ‘going concern’ is required in an organisation’s annual report.

 

GOODWILL

The excess paid by an acquiring business over the book value of the equity of the business acquired. For example, if A Limited pays £10m for B Limited and B Limited’s equity in its latest balance sheet is £8m, goodwill is £2m. Goodwill is an example of an intangible fixed asset.

 

GROSS PROFIT and GROSS PROFIT MARGIN

The difference between revenues and the cost of sales. It can be calculated for a business as a whole and for individual products and services within a business.

Gross profit margin is the gross profit divided by revenues expressed as a percentage. It measures both the profitability and the relative profitability of a business’s products and services. There is no overall gross profit margin benchmark because gross margins vary significantly from business sector to business sector.

 

GROUP ACCOUNTS

See minority interest.

 

H

HISTORICAL COST

This is the traditional way of stating the value of assets in a balance sheet and costs in the income statement. The valuation criterion is the cost at the time of purchase. This system of accounting is known as historical cost accounting (HCA). Some financial statements are prepared under HCA modified by the revaluation of certain assets, usually property, to their current value.

 

HOLDING COMPANY/PARENT COMPANY

The parent company which owns a controlling interest in one or more subsidiaries. See minority interest.

 

I

INCOME

The American term for profit. Net income is the profit after taxation or earnings.

 

INCOME STATEMENT

See profit and loss account.

 

INSOLVENT

Unable to meet commitments as they fall due. This will happen when an organisation does not have enough cash to pay its cash costs and/or when a company’s liabilities exceed its assets. It is an offence for an organisation to operate when it is insolvent.

 

INTANGIBLE ASSETS

Items of value that do not have a physical shape. Examples are brand names, goodwill and intellectual property such as patents and trade marks.

 

INTEREST COVER

An indicator of solvency which is the ability of an organisation to meet its financial commitments. It is calculated by expressing profit before interest and taxation (the operating or trading profit) as a multiple of the interest charge. It is a measure of the ability of an organisation to service its financing costs from the profit it earns from its day-to-day activities. The higher the interest cover, the better since that indicates the organisation concerned is more able to afford its financing costs. The lower the interest cover, the less able an organisation is to service its financing costs.

A benchmark for interest cover is 3 to 4 times.

 

INTERNAL RATE OF RETURN (IRR)

The rate of return or discount rate used in the financial appraisal of a long term project, such as the launch of a new product, producing a net present value (NPV) of cash flows equal to zero. The IRR should exceed the cost of capital. It is the maximum cost of capital that an organisation can sustain before a project becomes uneconomic and destroys shareholder value.

 

INVENTORY

The American term for stocks of raw materials, work-in-progress and finished goods.

 

INVESTMENTS

Long term investments are investments in other businesses such as a Joint Venture. They will appear under fixed or non-current assets in the balance sheet.

Short term investments refer, for example, to cash balances that are placed on deposit to earn a return. They appear under current assets in the balance sheet.

 

J

JOINT VENTURE

A long term investment; an investor shares control with one or more other parties under a formal contractual arrangement.

 

L

LEASE

The hire of a fixed or non-current asset such as plant and machinery from a leasing company; the lessor.

There are two kinds of leases:

  • An operating lease is a short-term contract. At the end of the period, the asset concerned is returned to the lessor by the lessee. The leasing costs are charged to the income statement for the appropriate period.
  • A finance lease is a long-term contract. The value of the leased asset is shown or ‘capitalised’ in the lessee’s balance sheet (unlike an operating lease). The commitment to the lessor is split between short and long-term liabilities. The asset concerned is depreciated each year by the amount of the capital repayments. Interest charges on the lease agreement are charged to the income statement.

 

LIFO (Last-in first-out)

A method of stock valuation which assumes that the last item delivered into stock is the first to be used. The cost charged in the income statement is, therefore, the most recent cost and, in times of inflation, will be higher than under FIFO (First In First Out).

 

LIABILITY or LIABILITIES

Amounts owed by an organisation to external parties. Its usage varies. In a balance sheet, ‘total liabilities’ can mean equity plus amounts due to creditors. More generally, it means amounts owed to third parties or creditors only such as banks and suppliers.

 

LIMITED COMPANY

A company is a separate legal entity belonging to the shareholders who own it. Limited means that the liability of the shareholders is limited to the amount they have invested in the company.

Public limited company (plc) means that the company has a certain minimum issued share capital. All other companies are ‘private’. A public limited company may be a ‘quoted’ company – a company whose shares are listed on the Stock Exchange and whose shares can be bought and sold. A ‘quoted’ company is also referred to as a ‘listed’ company.

 

LIQUIDITY

The extent to which an organisation has access to cash. It is an indicator of the ability of an organisation to meet its short-term commitments. ‘Liquid’ organisations are financially healthy. ‘Illiquid’ organisations are not.

If a company expands too quickly, accounts receivable or trade debtors, stocks and capital expenditure may increase so fast that creditors cannot be paid promptly because insufficient cash flow is being generated. This is called ‘overtrading’.

 

LIQUID RESOURCES

Cash and bank balances plus short-term investments which can be easily converted into cash such as money market deposits and stock market investments.