9.6: Chapter Glossary and Notes

Glossary

Income statement. This financial statement indicates what you expect sales and expenses to be and subsequently your profitability. The income statement indicates weekly, monthly and yearly profitability from operation.

Financial statements and Creditors. Creditors are ultimately concerned with a borrower's ability to make interest and principle payments.

Financial statements and Investors. Investors will usually attempt to arrive at an estimation of a company's future earnings stream.

Financial statements and Management. Management must consider financial statement analysis as it relates to a 'variety' of user groups including creditors, investors, employees, general public, regulators, financial press, and so forth. Management must always demonstrate an understanding of the company in terms of profitability and competitive advantage.

Income statement or profit and loss account (P&L), statement of profit or loss, pro-forma, revenue statement, statement of financial performance, earnings statement, operating statement, or statement of operations) is one of the financial statements of a company and shows the company’s revenue and expenses during a particular period. It indicates how the revenues (money received from the sale of products and services before removing expenses, also known as the “top line”) are transformed into the net income (the result after all revenues and expenses have been accounted for, also known as “net profit” or the “bottom line”). It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write offs (e.g., depreciation and amortization of various assets) and taxes. In sum, the oncome state is measure of revenue and expenses to arrive at a profit or loss figure. It is nothing more than:

Revenue – Expenses = Net Profit/Loss

The purpose of the income statement is to show managers and investors whether the company made or lost money during the period of the report. One important thing to remember about an income statement is that it represents a ‘period of time’.

Single Step income statement. Takes the simpler approach, totaling revenues (income) and subtracting expenses (expenses) to find the bottom line (profit).

Multi-Step income statement. Takes several steps to find the bottom line, starting with the gross profit. It then calculates operating expenses and, when deducted from the gross profit, yields income from operations. Adding to income from operations is the difference of other revenues and other expenses. When combined with income from operations, this yields income before taxes. The final step is to deduct taxes, which finally produces the net income for the period measured.

Revenue. Cash inflows or other enhancements of assets (including accounts receivable) of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major operations. Every time a business sells a product or performs a service, it obtains revenue referred to as gross revenue or sales revenue. An operation would generally equate revenue to be sales minus sales discounts, returns, and allowances. This is an important calculation because revenue is taxable by federal state, and local governments. An operation should pay tax on the revenue it actually receives.

Revenue = sales minus discounts, returns, and allowances

Expenses. Cash outflows or other using-up of assets or incurrence of liabilities including accounts payable during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major operations.

Cost of Goods Sold (COGS) or Cost of Sales. Cost of sales represents the direct costs attributable to goods produced and sold by a business (manufacturing or merchandizing).

Balance sheet or statement of financial position. A summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company. Assets, liabilities and ownership equity list as of a specific date, such as the end of its financial year. A balance sheet is a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement that applies to a single point in time of a business' calendar year.

Standard company balance sheet. This sheet has two sides: assets, on the left and financing, which itself has two parts, liabilities and ownership equity, on the right. The main categories of assets usually list first and typically in order of liquidity. Liabilities follow assets. The difference between the assets and the liabilities is equity, or the net assets or the net worth or capital of the company and according to the accounting equation, net worth must equal assets minus liabilities.

Personal balance sheet. lists current assets such as cash in checking accounts and savings accounts, long-term assets such as common stock and real estate, current liabilities such as loan debt and mortgage debt due, or overdue, long-term liabilities such as mortgage and other loan debt. Securities and real estate values list at market value rather than at historical cost or cost basis. Personal net worth is the difference between an individual's total assets and total liabilities.

Small business balance sheet. Lists current assets such as cash, accounts receivable, and inventory, fixed assets such as land, buildings, and equipment, intangible assets such as patents, and liabilities such as accounts payable, accrued expenses, and long-term debt. Contingent liabilities such as warranties enter in the footnotes to the balance sheet. The small business's equity is the difference between total assets and total liabilities.

Financial ratio or accounting ratio. A relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios are useful to managers within a firm, to current and potential shareholders (owners) of a firm, and to a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies.

Ratio. A relationship between two numbers indicating how many times the first number contains the second. For example, if a bowl of fruit contains ‘eight’ oranges and ‘six’ lemons, then the ratio of oranges to lemons is eight to six (that is, 8:6, which is equivalent to the ratio 4:3). A ratio is written "a to b" or ‘a: b’ or sometimes expressed arithmetically as a ‘quotient’ of the two.

Current ratio. A liquidity ratio that measures whether or not a firm has enough resources to meet its short-term obligations. It compares a firm's current assets to its current liabilities.

Acid test’ or quick ratio. Measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets include those current assets that presumably can quickly convert to cash at close to their book values.

Working capital. A financial metric, which represents operating liquidity available to a business, organization or other entity, including governmental entity. Working capital is the difference between the current assets and the current liabilities. Along with fixed assets such as plant and equipment, working capital is a part of operating capital. Gross working capital equals to current assets. Working capital calculation is ‘current assets’ minus ‘current liabilities’.

Notes

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