CTP - Module 1-6

Financial statements

Accounting reports that summarize a company's operating results and financial position at a point in time. Analyzing these statements provides insights into (1) how well the company has managed its liquidity position, (2) how effectively it used and financed its assets, (3) whether it had a proper balance between debt and equity financing compared to peers, (4) how well it controlled operating and financing costs, and (5) whether the profit it earned was satisfactory in relation to the levels of revenue it experienced and the investment in assets that support its operations.

Goodwill

An account that can be found in the assets portion of a company's balance sheet. This can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over book value usually accounts for the target firm's intangible assets.

Materiality

An accounting concept that involves determining the significance of the impact of information on the financial position of the entity being reported. In most accounting applications, there is usually a significant degree of judgment involved in the preparation of the accounts. Where decisions are required about the appropriateness of a particular accounting judgment, the materiality convention suggests that this should only be an issue if the judgment is significant or material to the presentation of the accounts. The concept is therefore an important issue for auditors of financial accounts.

Master budget

An annual budget for an entire organization. This has two chief components: (1) the operating budget or profit plan, and (2) the financial budget.

Accumulated depreciation

An asset account that records the amount of depreciation previously expensed on a company's assets. It appears on the asset side of the balance sheet, but it is a source of funds when it increases. While depreciation is technically a noncash expense (i.e., there is no actual payment for depreciation), it does have a cash flow impact because it reduces the company's income taxes by lowering pretax income.

Cash conversion efficiency

An efficiency/asset management ratio that measures how effectively a company has converted sales (or revenues) into cash. It is computed as cash flow from operations divided by revenues.

Fixed asset turnover ratio

An efficiency/asset management ratio that measures how efficiently fixed assets (or property, plant, and equipment) are used. It is computed as revenues divided by net property, plant, and equipment.

Total asset turnover ratio

An efficiency/asset management ratio that measures how many times a firm's asset base was used (i.e., turned over) in generating the flow of revenue during the period. It is computed as revenues divided by total assets.

Current asset turnover ratio

An efficiency/asset management ratio that measures how many times the firm has turned over the stock of its most liquid assets with the flow of revenue. It is computed as revenues divided by current assets.

Independent auditor

An external auditor with a certified public accounting designation that qualifies him or her to provide an auditor's report. May also be used to refer to a public accounting firm that employs qualified external auditors.

Financial Accounting Standards Board (FASB)

An independent, self-regulating US organization made up of accounting professionals that establishes financial accounting and reporting standards in the United States, collectively referred to as Generally Accepted Accounting Principles (GAAP).

DuPont equation

An integrated ratio analysis technique that looks at the return on total assets (ROTA) ratio as a product of the return on sales (i.e., net profit margin) and total asset turnover.

International Accounting Standards Board (IASB)

An international standards-setting body that determines general accounting standards and is made up of board members from nine countries. Based in London, England, their mission is to develop a single set of global accounting standards published as pronouncements called International Financial Reporting Standards.

Auditor's opinion

An opinion on a company's financial statements that is provided by an independent auditor (or audit firm) based on a financial audit. The purpose of conducting an audit is to produce an audit report in which an independent audit firm indicates the scope of the audit and renders an opinion regarding the relevance, completeness, and accuracy of the income statement, statement of financial position, statement of cash flows, any other statements, and all supporting material. In addition, the auditor will examine the strengths of the organization's internal controls and processes. The auditor's opinion does not comment on the company's financial fitness, but rather on whether the financial statements fairly reflect the company's financial position and are comparable to prior periods.

Financial planning

An organizational function that involves determining the need for present and future funding to support operations. An important part of this function is the forecasting of revenues, income, and external financing required to support the company's planned growth.

Intangible assets

Assets that lack physical substance and for which there is often a high degree of uncertainty concerning their future value. Examples are goodwill, trademarks, and patents. This type of asset with a finite and useful life is amortized over its legal or useful life, but if it has an indefinite useful life, it is not amortized. However, it must be evaluated annually for any decline in value, which must be charged against income when identified.

Variable costs

Costs in a business whose total amount changes in direct proportion to the level of business activity. In cost accounting, these costs are contrasted with fixed costs, which do not change based on volume or activity levels.

Fixed costs

Costs that do not vary in total over a wide range of activity and are not immediately impacted by changes in business activities. In cost accounting, fixed costs are contrasted with variable costs, which do change based on volume or activity levels.

Coverage ratios

Financial ratios concerned primarily with measuring a company's ability to make payments on (i.e., service) its debt.

Future value (FV)

For an investment made today, this is the expected value of the investment at a specified, future date.

Functional currency

For determining foreign exchange translation exposure, this is the currency of the primary economic environment in which the entity operates. Normally, the majority of the entity's business activities are transacted in that currency.

Service industry ratios

Ratios used in ratio analysis of firms in the service sector. Service companies typically have small investments in buildings and land, and rely more on human talent than physical assets.

Liquidity

The ability of an organization to convert assets into cash quickly and without a significant risk of loss.

Accrual accounting

The accounting approach under which expenses must be reported when the revenues with which they are associated are recognized. Long-lived or fixed assets are capitalized (i.e., recorded as assets on the balance sheet) and depreciated over time because they produce revenues over many accounting periods. This practice matches an asset's cost to the revenues it produces. Under the revenue recognition and matching principles, sales are reported even though cash has not been received. Similarly, expenses are reported even though cash has not been paid out.

Governmental Accounting Standards Board (GASB)

The authoritative standard-setting body for US state and local governments, as well as for public schools, state universities, and other government-affiliated agencies.

Home currency

The currency of the country in which an entity's headquarters are located. In foreign exchange translation, if the functional currency of the subsidiary is this, then the current method is used to translate financial statement line items to the parent company's currency. The current method translates all assets and liabilities at the current spot rate at the date of translation.

Accounting Standards Codification (ASC)

The detailed set of rules in the United States, referred to as Generally Accepted Accounting Principles, that are developed, agreed upon, and published in the form of ASC Topics by the Financial Accounting Standards Board, an independent, self-regulating organization formed in 1973.

Internal rate of return (IRR)

The discount rate that makes the net present value equal to zero or, equivalently, makes the present value (PV) of cash inflows equal to the PV of cash outflows.

Cost of goods sold (COGS)

The expense associated with providing the goods or services whose sale is recognized as revenues. It includes labor and material directly used in manufacturing the product sold, as well as any indirect or allocated manufacturing expenses.

Financial Accounting Standards (FASs)

The former name of Accounting Standards Codification (ASC) Topics.

Chief executive officer (CEO)

The highest ranking executive in a company whose main responsibilities include developing and implementing high-level strategies, making major corporate decisions, managing the overall operations and resources of a company, and acting as the main point of communication between the board of directors and the corporate operations.

Equity capital

The invested capital of an organization (as contrasted with borrowed or debt capital). From an accounting point of view, this consists of all preferred and common equity accounts, including retained earnings, and is typically represented by securities such as shares of common and preferred stock.

Capital

The more permanent sources of funds used by a company, such as long-term debt, preferred stock, and common equity.

Payback period

The number of years required to recover the initial investment in an asset or project.

Integrated ratio analysis

The practice of looking at various financial ratios in pairs or groups to gain better insight into a company's financial performance.

Capital budgeting

The process by which proposed large-dollar investments in long-term assets are evaluated.

Disaster recovery

The restoration of systems and communications after an event causes an outage.

Chief financial officer (CFO)

The senior manager who is responsible for overseeing the financial activities of an entire company. This includes signing checks, monitoring cash flow, and financial planning.

Cash management

The subset of treasury management that specifically deals with managing the daily liquidity (available cash) of a company or organization to ensure the company or organization can meet its short-term obligations.

Working capital

The sum of a company's current asset accounts (primarily cash, accounts receivable, and inventory) less the sum of its current liability accounts (primarily payables and accrual accounts). Also known as net working capital.

Comprehensive income

The sum of net income and other items that must bypass the income statement because they have not been realized, including items like an unrealized holding gain or loss from available-for-sale securities and foreign currency translation gains or losses.

Working capital gap

The time gap between a cash outflow and a cash inflow.

Present value (PV)

The value at the present time of anticipated future cash flows or payments.

Opportunity cost

The value of the best alternative not taken when two or more mutually exclusive alternatives are available.

Fair value

Under Accounting Standards Codification (ASC) Topic 820, an asset or liability is defined by determining the price that would be received in an asset sale or the price paid to transfer a liability. The valuation price must be market-based and take into consideration all observable valuation inputs, such as competition and risk. ASC Topic 825 expands this application by stating that this should be applied to all financial assets and liabilities except for certain specified types of assets.

Independent director

Under New York Stock Exchange standards, this is a director who has no material relationship with the listed company, either directly or as a partner, shareholder, or officer of the organization.

Weighted average cost of capital (WACC)

Used in determining the overall cost of capital, this cost is computed as a weighted average of the effective cost of debt and the cost of equity.

Outsourcing

Utilizing a third party to perform all or part of a core function.

Retained earnings

A balance sheet account that represents the accumulated net earnings of a corporation since its inception, less dividends paid to shareholders. It also represents the changes in shareholders' equity arising from the retention of profits and losses of the company, less any dividends paid out to shareholders.

Financial budget

A component of a master budget, this budget addresses an organization's financing and investing activities.

Operating budget

A component of a master budget, this budget focuses on day-to-day operations. Also known as a profit plan.

Financial leverage

A concept that examines the fixed costs of financing. Generally, the higher the level of debt capital used in a company, the higher the interest costs and the greater the amount of financial leverage. This is also the measure of a company's use of debt in its capital structure.

Operating leverage

A concept that examines the responsiveness of operating profits to changes in sales. This is determined by the extent to which fixed costs are used in a company's operating cost structure. The higher the proportion of fixed costs, the higher this is for the company.

Profitability index (PI)

A cost/benefit measurement that is similar to net present value, this is a ratio of the present value gained to the cost required to obtain that value. It shows value gained per dollar of investment. This is calculated as present value of cash inflows divided by present value of cash outflows.

Fixed-charge coverage ratio

A coverage ratio that is similar to the times interest earned ratio but also takes into account fixed charges other than interest, such as payments on leases. It is computed as earnings before interest and taxes (EBIT) plus fixed charges, divided by interest expense plus fixed charges.

Times interest earned (TIE) ratio

A coverage ratio that measures a firm's ability to service its debt through interest payments. It is computed as operating income (i.e., earnings before interest and taxes, or EBIT) divided by interest expense.

Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database

A database that contains a searchable listing of US Securities and Exchange Commission filings for public companies.

Shared services center (SSC)

A department or operation within a multiunit organization tasked with supplying multiple business units and their respective divisions and departments with specialized services, such as information technology (IT), human resources (HR), or accounts payable (A/P) services. In some companies this includes day-to-day treasury operations (cash management) and other treasury functions, which may be operated as this.

Generally Accepted Accounting Principles (GAAP)

A detailed set of rules that govern US accounting standards. These principles are developed, agreed upon, and published in the form of Accounting Standards Codification (ASC) Topics by the Financial Accounting Standards Board (FASB).

Acceptance

A drawee's signed agreement to pay a negotiable instrument (typically a letter of credit or related draft) as presented. This acknowledges that all of the terms of the instrument, other than time, have been met and the instrument will be paid at the proper time.

Derivative

A financial product that acquires its value by inference through a formulaic connection to another asset. The other asset is termed the underlying asset, and can be a financial instrument (e.g., a stock or bond), currency, or commodity.

Common-size financial statement

A financial statement analysis technique that involves stating line items as percentages rather than amounts. This expresses every line item on the statement as a percentage of revenue, and a common-size balance sheet expresses each account as a percentage of total assets. These enable direct comparisons of financial data for firms of different sizes.

Statement of cash flows

A financial statement that provides a detailed picture of the sources of a company's cash flows and how these sources are used.

Income statement

A financial statement that summarizes revenues earned, expenses incurred, and gains and losses arising from conversions of assets and liabilities over an accounting period. Also called a statement of earnings, a statement of operations, or a profit and loss statement.

Time value of money

A fundamental finance principle that establishes the relationship between cash flows received at different times. For example, a dollar received today is worth more than a dollar received tomorrow because today's dollar can be invested to earn a return. Conversely, a dollar received tomorrow is worth less than a dollar received today because the opportunity to earn interest is lost.

Board of directors

A group of individuals that are elected as, or elected to act as, representatives of the stockholders to establish corporate management-related policies and to make decisions on major company issues. Such issues include the hiring/firing of executives, dividend policies, options policies, and executive compensation. Every public company must have this.

Cash basis accounting

A major accounting method that recognizes revenues and expenses at the time physical cash is actually received or disbursed.

Earnings before interest and taxes (EBIT)

A measure of operating income or profit that is calculated as gross profit less operating expenses, depreciation, and amortization. It has traditionally been the measure used to evaluate a firm's ability to generate operating profits and to meet its financial and tax obligations.

EBITDA margin

A measure of operating profitability calculated by dividing EBITDA (earnings before interest, taxes, depreciation, and amortization) by total revenues.

Earnings before interest, taxes, depreciation, and amortization (EBITDA)

A measure of operating profitability that is calculated as gross profit less operating expenses (but not subtracting depreciation and amortization). It first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods. Many companies, especially in the technology sector, now commonly quote this.

Scenario analysis

A method for assessing investment risk, this type of what-if analysis assesses possible outcomes under a range of circumstances. It is used frequently to establish the lower bound (i.e., worst case) and upper bound (i.e., best case) of outcomes. This is similar to sensitivity analysis, but more than one variable is altered at a time. This usually starts with a base case-an expected value for each input variable affecting the final value.

Simulation

A method of assessing investment risk, this method combines scenario and sensitivity analyses, allowing certain assumptions in a decision model to fluctuate simultaneously.

Sensitivity analysis

A method of assessing investment risk, this type of analysis determines how a final outcome, such as net present value, is influenced by changes in the value of a particular variable (e.g., sales, or an operating or financing cost) and how vulnerable the expected outcome is to changes in a specific assumption. Note that with this analysis only one variable at a time is changed, rather than a set of variables.

Risk-adjusted return on capital (RAROC)

A method of determining the economic value of a transaction or activity based upon the anticipated risk-adjusted performance of the activity.

Return on investment (ROI)

A performance measurement ratio that calculates profit per dollar of invested capital. It is computed by dividing net income by invested capital (or long-term debt and equity).

Free cash flow (FCF)

A performance measurement ratio that is similar to residual income analysis but which-in addition to accounting for capital costs-also includes adjustments for noncash items and for working capital investments. Its primary objective is to determine the amount of effective cash flow available to a company after all necessary investments have been accounted for. To this end, it is used extensively in the analysis of new or high-growth companies, especially by the providers of venture capital. It is most commonly computed by adding net income to depreciation and amortization, less the change in working capital and capital expenditures.

Economic value added (EVA)

A performance measurement ratio that isolates the funds available to all suppliers of capital and then relates that total to the amount of capital supplied. It can be computed as earnings before interest and taxes (EBIT), times one minus the company's tax rate, and then subtracting the product of the weighted average cost of capital and long-term debt and equity.

Return on assets (ROA)

A performance ratio that measures net income in relation to the investment in assets. A greater value for this ratio implies a larger net income per dollar invested in assets. It is computed as net income divided by total assets.

Return on common equity

A performance ratio that measures the amount of earnings available to common shareholders relative to the level of their investment in the company. It is computed as earnings available to common shareholders divided by common equity.

Net profit margin

A performance ratio that shows the percentage of profits earned after all expenses and taxes are deducted from revenues. It is defined as net income divided by revenues. Also known as return on sales or return on revenues.

Operating profit margin

A performance ratio that shows the percentage of revenue remaining after both the cost of goods sold and all operating expenses are deducted from revenue. It is computed as earnings before interest and taxes (EBIT) divided by revenues.

Gross profit margin

A performance ratio that shows the percentage of revenues remaining after the cost of goods sold is deducted from revenue. It is computed as gross profit divided by revenues.

Foreign currency translation

A process used to convert the financial results of a parent company's foreign subsidiaries to its reporting currency.

Indebtedness/debt ratio

A ratio used to measure the level of indebtedness or use of leverage (i.e., debt usage) by a company.

Economies of scale

A relationship that occurs when an increase in sales lowers the average cost per unit sold.

Operating cycle

A representation of the flow of funds through a company from the acquisition of raw materials, through the production cycle and the sale of products or services, and finally to the collection of payments from customers.

Account reconciliation program (ARP)

A service offered by a financial institution that matches issue information to paid check information and reports outstanding/unpaid items.

Risk-adjusted discount rate (RADR)

A type of cost/benefit analysis that essentially requires high-risk endeavors to earn a higher rate of return in order to justify the investment. When properly applied, this allows a firm to more closely match its capital needs to available sources and to better manage its overall levels of risk and return.

Break-even analysis

A type of cost/benefit analysis that establishes the level of activity at which benefits and costs are equal.

Long-term debt to capital ratio

A type of debt management ratio that measures the percentage of a company's capital (where capital is defined as the sum of long-term debt and equity) that is provided by long-term debt. It is computed as long-term debt divided by long-term debt plus equity.

Total liabilities to total assets ratio

A type of debt management ratio that measures the percentage of all liabilities to total investments or total assets. It is computed as total liabilities divided by total assets.

Debt to tangible net worth ratio

A type of debt management ratio that reflects the impact of intangible assets (e.g., goodwill, patents, trademarks, and copyrights) on the balance sheet. It is computed as total debt divided by total equity minus intangible assets.

Net present value (NPV)

A type of financial analysis, this value is calculated by netting the present value (PV) of anticipated cash inflows with the PV of cash outflows.

Net investment hedge

A type of hedge designed to hedge currency risk associated with the translation of subsidiary (or other foreign operations) financial statements into the parent firm's functional currency.

Fair value hedge

A type of hedge in which the risk being hedged is a change in the fair value of an asset or a liability. Changes in fair value may arise through changes in interest rates (for fixed-rate loans), foreign exchange rates, equity prices, or commodity prices.

Governmental and not-for-profit (G/NFP) organization

A type of organization that does not have shareholders or other owners, but is organized to serve a collective group. These agencies provide goods, services, or information to benefit the public as a whole or its particular segments. They raise cash primarily through taxes and fees paid by members of the community, regardless of whether those paying such taxes and fees derive any benefit from the resulting goods or services. These organizations serve specific constituencies who pay for some or all the benefits provided.

Efficiency/asset management ratios

A type of ratio that measures how effectively assets are utilized.

Performance ratio

A type of ratio that measures profit relative to the amount of revenue or the level of financing.

Liquidity/working capital ratio

A type of ratio that measures the firm's ability to meet its payment obligations on short-term debt and helps ascertain whether cash is being used effectively.

Debt management ratio

A type of ratio that measures the firm's degree of indebtedness and its ability to service its debt.