Words Used in… Corporate Finance
Take a quick look at the financial pages of any major newspaper. You'll see all sorts of terms and phrases that have a very specific meaning to those who work in the world of corporate finance. For others, however, these terms can seem confusing – or even intimidating!
This Mind Tools "Words" page is designed to help you navigate your way through the language of finance. We provide a quick-reference glossary of many words and phrases commonly used when discussing publicly traded companies. This "Words" page covers the following terms:
Financial Analysis Terms
- Acid-Test Ratio/Quick Ratio
- Break-Even (BE)
- Cost Accounting
- Current Ratio
- Gearing Ratio/Financial Leverage
- Management Accounting
- Net Present Value (NPV)
- Opportunity Cost
- Present Value (PV)
- Ratio Analysis
- Return on Investment (ROI)
- Zero-Based Budgeting (ZBB)
General Corporate Finance Terms
- Common Stock
- Debt Financing
- Equity Financing
- GAAP (Generally Accepted Accounting Principles/Practices)
- IPO (Initial Public Offering)
- Mergers and Acquisitions (M&A)
- P/E (Price to Earnings) Ratio
- Preferred Stock
- Retained Earnings
Financial Analysis Terms
"Quick assets" divided by current liabilities. This is a test of a company's solvency/financial strength, or ability to pay its debts. Quick assets are cash, accounts receivable, or easily liquidated assets; they do not include inventory. Current liabilities are debts that must be paid in the next year.
The point in time at which total revenues received equal total costs so far. In many projects, an investment is needed at the start of the project, with profits received in a stream once this investment has been made. Break even occurs when profits received are equal to the investment made. Calculating the projected break even point in a project is usually the minimum standard for determining whether or not to continue with it, or make an investment.
The tracking and analyzing of costs associated with operations. The results are used internally within an organization for a range of purposes including estimating and constructing budgets, and other financial forecasts.
Current assets divided by current liabilities. This shows the organization's ability to repay short-term creditors, and it indicates solvency/financial strength. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses, and so on. (See also the acid-test.)
The ratio of equity capital to borrowed capital or debt financing. Companies with higher proportions of equity are usually considered financially stronger.
When an organization is unable to pay due debts.
Preparation and tracking of the accounting statements and financial data that a company's management use to make efficient business decisions, often during a business year. These statements are not intended for use outside the company or for tax reporting.
The difference between the present value (in today's money) of an investment's costs, and the present value of the cash flows that will be derived from it in the future. This is the net contribution or profitability of an investment or project, and it's a useful measure of the worth of a project or investment.
The benefits you miss out on by not investing in a particular opportunity or project, because you're investing in another project. The term opportunity cost can be used to refer to non-financial benefits as well.
The value of future income in today's money. This considers the "time value of money". For instance, the present value of $500,000 received a year from now is less than $500,000, because you could invest the money today and start earning interest immediately. To determine what future revenue is worth today, divide it by 1+the percentage interest rate you'd get from the bank for the period, raised to the power of the number of years ahead that you'll receive the money.
A ratio is the result of dividing one number by another. Ratio analysis involves comparing financial figures from different years, or between different line items of a company's financial statements. Common ratios used in financial analysis include the current ratio and the quick ratio.
Net income from an investment divided by the cost of that investment. ROI, or simply "return," measures the efficiency or profitability of an investment. It can also measure the overall profits generated by a company – to show operational efficiency and the effectiveness of management.
A method of preparing a budget in which you start from the beginning and evaluate each item separately, assuming that you have no pre-approved funds left over from the previous period. Therefore, you justify and prioritize your needs using revenue and expense projections. This is different from traditional budgeting, in which you assume that past revenue and expenses will continue, and you uplift each line item by a certain percentage.
General Corporate Finance Terms
A security in which the holder lends money to the issuing company, instead of owning stock in the company. The company then owes the bondholder the principal (amount borrowed) plus interest that will be paid at a later date that's fixed at the time the bond is taken out. This interest can be fixed or variable, and it's paid on the maturity date.
Stock, or ownership, in a company. The owner receives voting rights and earns a portion of the company's profits, either through dividends and/or an increase in the price per share. Common stockholder dividends are not guaranteed and can vary according to profitability. If a company is liquidated or goes bankrupt, common stockholders are paid after creditors, bondholders, and preferred stockholders, sometimes meaning that they receive nothing at all. Common stock is a US term equivalent to ordinary shares in the UK.
When money to fund operations or invest in capital assets is raised through loans from banks or other creditors. In exchange for the loan, the organization agrees to repay the principal (borrowed amount) plus interest.
The distribution of earnings paid to owners of a corporation's stocks.
When money to fund operations or invest in capital assets is raised by selling a share of ownership of the business to outside investors. In public companies, equity is in the form of stock.
A predetermined set of guidelines for preparing financial statements. These standard practices allow you to compare the financial statements of one company with others. North America and the UK use GAAP (albeit different versions). International companies often use International Financial Reporting Standards (IFRS), and IFRS also includes International Accounting Standards (IAS). Other countries may follow their own sets of accounting practices and standards.
When a private company first sells shares to the public ("goes public"). Companies use IPOs as a way to gain funds for operation and expansion. The alternative is to borrow money, increasing debt financing.
When the operations, assets and liabilities of one company are combined and managed with another company. In a merger, the shares of both companies are usually exchanged for shares in the merged company, and the names of both organizations can be joined together (Royal Dutch Shell is a good example). In an acquisition, one company buys another company, and the purchased company's name often disappears, or is simply used as a brand name by the acquirer for a product or service line.
Market price per share divided by annual earnings per share. Investors use this common ratio to determine whether they should purchase shares in a company. Oftern, investors want a high return – i.e. a low P/E – on their investments. Where people are buying stock at a high P/E, it implies that they're expecting much higher profits in the future than they're getting now.
Stock, or ownership, in a company. Preferred stockholders typically receive fixed dividend payments and usually have no voting rights. However, if a company is liquidated or goes bankrupt, preferred stockholders are paid before common stockholders, but after bondholders and other creditors.
The portion of earnings that's reinvested in the company rather than paid out in dividends to stockholders.
The annual rate of return on an investment, usually given as a percentage of the money originally invested.