Important terms and definitions
A free best practices guide for essential ratios in comprehensive financial analysis and business decision-making.
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Written byTim Vipond
Below is a glossary of terms and definitions for the most common financial analysis ratios terms. When calculating financial ratios using vertical and horizontal analysis, and ultimately the pyramid of ratios, it’s important to have a solid understanding of basic terms. The below information is taken from CFI’s Financial Analysis Fundamentals Course.
Accounts Payable
Synonyms: payables, creditors
Accounts Payableis the amount owed by an organization to others for goods or servicesreceived. Buying from suppliers on credit will generate accountspayable.
Accounts Receivable
Synonyms: receivables, debtors
Accounts Receivableis the amount due to an organization for goods delivered or servicesrendered. Selling to customers on credit will generate accountsreceivable for a business.
Accounts Payable Days Ratio
Accounts payable / COGS x 365. Average number of days a firm takes topay for items purchased.
Accounts Payable Turnover
Cost of sales / Accounts payable (either the ending balance or averagebalance). This ratio measures how effective management is in paying itssuppliers.
Accounts Receivable Days Ratio
Accounts receivable / Sales x 365. Average number of days a firm takesto collect payments on goods sold.
Accounts Receivable Turnover
Sales / Accounts receivable (either the ending balance or average balance). This ratio measures how effective the company’s credit and collection policies are.
Acid Test
See quick ratio.
Administration Cost Ratio
Administration costs / Sales. This margin shows the general overheadcost for each dollar of sales.
Amortization
The gradual reduction of a financial amount over time.
Assets
Assets are resources owned and employed by an organization thatconfers futureeconomic benefits.
Asset Turnover Ratio
Sales / Total assets. This ratio shows how effective the company is ingenerating sales from its assets.
Audit
Auditis the process of examination and verification of a firm’s books of account,transaction records, and other relevant documents, including financialmodels.
Average Balance
(Opening balance – Closing balance) / 2. This balance can be used tocalculate efficiency/turnover ratios instead of using a closing balance.
Balance Sheet
TheBalance Sheetis a snapshot of an organization’s assets and liabilities on a particular date. The balance sheet shows the sources of funds provided to an organization (called the capital employed and normally either equity or debt) and how those funds have been used by the organization to invest in fixed assets (assets the organization intends to keep for more than one year) and working capital (money tied up in the day-to-day operations of the business)
Capital
See capital employed.
Capital Asset
Assets such as property, plant, and equipment employed to generateincome.
Capital Employed
Synonyms: capital
Capital employed represents the funds provided to an organization inthe form of equity or debt.
Capital in Excess of Par Value
See contributed surplus.
Capital Stock
Synonyms: stock, shares, share capital
There are two types of stock – common stock and preferred stock. Most shares tend to be common stock and generally carry one vote each and carry an equal right to a proportionate share of dividends.Capital stock is not a liability in the sense of other sources of funds (e.g., bank loans) since it is not generally paid back to shareholders unless the company is wound up.
Cash Flow Statement
The Cash Flow Statement is a summarized bank statement that shows an organization’s sources of cash during the financial year and the ways in which the cash has been used during that period (e.g., investments, fixed asset purchases, etc.).
Circular References
Circular references occur when a formula includes a reference to the cell in which the formula appears.
COGS
Cost of Goods Sold.
Common Shares
See common stock.
Common Stock
Synonyms: common shares, ordinary shares
Most shares tend to be common stock carrying one vote each and withan equal right to a proportionate share of dividends. Common stockdividends tend to rise as profits grow. This is in contrast to preferredstock where the dividend tends to be fixed.
Contributed Surplus
Synonyms: share premium, capital in excess of par value
Most stock is originally issued with a nominal/par value attached to it (e.g., one share in ABC Inc. has a nominal value of $1.00). However, if shareholders buy shares from the company for more than the nominal value (e.g. $1.50), then the excess is called the contributed surplus.
Coverage Ratios
Ratios that analyze a company’s liquidity or its ability to “cover” itsfinancial debt obligations. An example of a coverage ratio is EBITDA /Interest expense.
Creditors
See accounts payable.
Current Assets
Current Assets are all assets other than fixed assets. They are either cash or assets expected to be converted into cash or consumed by the business during the year. Current assets include items such as cash, accounts receivable, and inventory.
Current Liabilities
An organization’s liabilities due within one year. Current Liabilities includeitems such as short-term loans, any element of long-term loans duewithin one year, and accounts payable.
Current Ratio
Current assets / current liabilities. Current Ratio measures short-termliquidity, whether or not a company will have the ability to cover itsobligations in the short term.
DCF
Discounted Cash Flow analysis. A financial evaluation method that takesthe “time value of money” into account.
Debt
Debt is capital used to finance an organization that is subject to payment ofinterest over the life of the loan, at the end of which the loan is normallyrepaid.
Debt Financing
Raising money for a business through loans or by issuing bonds.
Debtors
See accounts receivable.
Depreciation
Synonyms: amortization
Depreciation of fixed assets is the process of allocating part of thecost of fixed assets to a particular accounting period. Depreciationis normally charged to the income statement on a straight-line basis(although there are alternative methods available). For example, if a caris bought for $15,000, has an expected life of 5 years, and has a residualvalue (expected scrap value) of $5,000, then the depreciation expensein the income statement will be $2,000 per year for 5 years. The valueof the car in the balance sheet would start at $15,000 but would be reduced by $2,000 a year. At the end of year 1, the net book value (NBV)of the car in the balance sheet would be $13,000. At the end of year 2,the NBV would be $11,000. The accumulated depreciation for the car atthe end of year 2 would be $4,000.
Direct Costs
Direct costs are those that are directly attributable to the product orservice provided by the organization. They are included in the cost of goodssold.
Dividends
A share of a company’s net profits distributed by the company to a classof its stockholders.
EBIT
Earnings Before Interest and Taxes. See operating profit.
EBIT Margin
EBIT / Sales.
EBITDA
Earnings Before Interest, Taxation, Depreciation, and Amortization.
Equity
Synonyms: shareholders’ equity, shareholders’ funds
Equity is total assets less total liabilities. Also called shareholders’ equity, networth, or book value.
Equity Financing
The money acquired from the business owners themselves or fromother investors.
Financial Covenants
Financial Covenantsare the promises made by the borrowing firm in a loan agreement toadhere to certain limits in the firm’s operations.
Financial Model
A Financial Model is a mathematical model describing the interrelationships among various financial variables. Typically, financial models are broken down into inputs, processing, and outputs.
Financial Statements
Financial Statements are statements, in financial terms, of the financial position of an entity ata given date, or of the results of its operations for a given period. Thestatements are normally prepared in one of a number of standardformats. Most commonly, when people refer to financial statements,they mean the income statement, the balance sheet, the cash flowstatement, and the related notes to the accounts.
Fixed Assets
Assets intended for use on a continuing basis in an organization’sactivities (normally defined as assets an organization intends to keepfor more than one year). There are three categories of fixed assets:intangible, tangible, and investments.
Forecast
The projection or estimate of future sales, revenue, earnings, or costs.
Goodwill
When one company buys another company it typically pays morethan the book value of the net assets acquired (because it is acquiringstaff, name/reputation, and customer relationships). This excess ofthe purchase price over the fair book value of the net assets is calledgoodwill. Goodwill is normally included in the balance sheet as anintangible fixed asset.
Gross Margin
Gross profit / Sales revenue. Gross margin shows how much was spentproducing the good or service that was sold for every dollar of salesrevenue.
Gross Profit
Gross Profitis sales revenue less cost of sales.
Income Statement
Synonyms: profit and loss account, P&L statement, statement ofearnings
TheIncome Statement is an organization’s financial history book and summarizes the revenue, expenses, and operating profit for the financial year. It also shows the tax charged against profit, how much of the profit for the year has been paid out in dividends, and how much has been retained in the business.
Inputs
Financial model assumptions that are used to drive model outputs.
Intangible Fixed Assets
Intangible fixed assets have no physical presence. Examples include patents, goodwill, trademarks, and brand names.
Interest Bearing Current Liabilities (IBCL’s)
These are liabilities that bear interest, normally short-term borrowings.They are excluded from some ratios in order to factor in the cost offinancing.
Interest Coverage Ratio
EBIT or EBITDA / Interest expense. This solvency ratio shows how much incomeis available to service debt costs.
Inventory
Inventorynormally refers to items held for resale and may include rawmaterials, work in progress, and finished goods.
Inventory Days Ratio
Inventories / COGS x 365. The average number of days goods remain ininventory before being sold.
Inventory Turnover Ratio
Sales / Inventory (either the ending balance or average inventorybalance). This ratio illustrates how a company manages its inventory.
Investing Activities
Deals or transactions involving sale or purchase of equipment, plant,properties, securities, or other assets.
Labor Cost Ratio
Direct labor / Sales. Cost of goods sold is made up of labor, materials,and direct costs. This margin shows the proportion of labor that goesto make up each dollar of sales.
Land and Buildings Ratio
Sales / Land and buildings. The sales generated from land and buildings are measured by this ratio.
Leverage Ratios
Leverage Ratiosare ratios that analyze a company’s solvency or the level of its debtfinancing relative to its equity financing. An example of a leverage ratio isTotal debt / Total shareholders’ equity.
Liabilities
Liabilitiesare money owed, or other financial obligations to other organizations and individuals.
Loan Capital
See debt.
Material Cost Ratio
Materials / Sales. Cost of goods sold is made up of labor, materials, anddirect costs. This margin shows the proportion of materials that goes tomake up each dollar of sales.
Model Structure
The framework around which a financial model is built.
Net Assets
Total assets less current liabilities (excluding IBCL’s).
Net Asset Ratio
Sales / Net assets. This ratio takes into account the financing of assets and measures management’s efficiency in relation to the use of assets.
Net Book Value
Net book value typically refers to property plant and equipment (PP&E).The net book value of PP&E is calculated by taking the total gross cost ofPP&E and deducting total accumulated depreciation/amortization.
Net Earnings
Synonyms: net income, retained profit for the year, retained earningsfor the year
The profits retained by an organization after all expenses including interest expenses, taxes, and dividends. The retained profits/earnings for a given year are reinvested in the business (hopefully making the organization grow, and increasing the value of its shares) and are added to retained earnings in the balance sheet (which represent all retained profits accumulated over an organization’s entire life to date which have been reinvested in the business).
Net Income
See net earnings for Net Income.
Net Profit Margin
Net income / Sales.Net Profit Marginshows how much is earned for everydollar of sales revenue.
Non-Current Assets
Assets that are not expected to be converted into cash within 12months of the balance sheet date.
Operating Activities
Synonyms: earnings before interest and income taxes (EBIT), profitbefore interest and income taxes (PBIT)
Cash inflows and outflows relating to a company’s operations. Examplesinclude receiving payments from customers, paying salaries, etc.
Operating Assets
Assets acquired for or used throughout the operations of the business(such as cash, inventory, prepaid expenses, equipment).
Operating Cost Ratio
Operating costs / Sales. This margin shows the operating expenses as a percentage of sales. This does not include cost of goods sold (as is the case with the operating profit margin), so it is an indication of the efficiency of the operation.
Operating Profit
Synonyms: earnings before interest and income taxes (EBIT), profitbefore interest and income taxes (PBIT)
Sales revenues less all operating expenses. Operating profit is calculatedbefore financing costs and taxes. It is often referred to as EBIT.
Operating Proft Margin
Operating Profit Marginis also known as the EBIT margin. Operating income / Sales. The performance ratio shows the cost of running the operation for eachdollar of sales.
Operating Revenues
The net sales revenue accumulated by a firm.
Ordinary Shares
See common stock.
Output
Financial model calculations that are driven by one or more inputs.
Personnel Cost Ratio
Personnel costs / Sales. The personnel costs used in this ratio couldbe research and development specific, or general overhead personnelcosts, or total personnel, depending upon the type of organization. Thismargin is useful in monitoring the amount spent on wages, salaries, andrelated expenses for each dollar of sales.
Plant and Machinery Turnover Ratio
Sales / Plant and Machinery. This ratio measures the efficiency of the use of a company’s operating assets.
Preferred Stock
Synonyms: preference shares
Preferred stock has preferential rights over common stock to both dividends and also to assets in the event that a company is wound up (i.e., preferred stockholders are paid out before common stockholders). Typically, preferred stock dividends are fixed (e.g., 6 percent) and do not increase with rising profits.
Processing
The translation of financial model inputs or assumptions into financialmodel outputs.
Property, Plant, and Equipment (PP&E)
are non-current fixed or capital assets such as buildings, computers, land,and vehicles.
Property, Plant, and Equipment (PP&E) Turnover Ratio
Sales / Property, Plant & Equipment. This ratio measures the sales acompany is able to generate from capital assets.
Quick Ratio
Current assets– Inventory / Current Liabilities. Quick Ratio is one of the financial analysis ratios that provides a more prudent measure of short-term liquidity recognizing that inventory cannot always be readily converted into cash.
Research and Development Cost Ratio
Research and development costs / Sales. This margin shows how muchthe company invests in developing the next generation of products orservices for each dollar of sales.
Research and Development Expenses
These expenses are directly attributable to researching and developingnew or improved products or systems.
Reserves
Reserves are part of shareholders’ equity. Reserves are subdivided into revenue reserves (e.g., retained earnings), which are available to be distributed to the shareholders by way of dividends, and capital reserves (e.g., contributed surplus), which for various reasons are not distributable as dividends.
Retained Earnings (Balance Sheet)
Synonyms: P&L reserve, Retained earnings reserve
Retained earnings on the balance sheet represent all retained profitsaccumulated over an organization’s entire life to date which have beenreinvested in the business. As the retained earnings ultimately belong toshareholders, they are included as part of shareholders’ equity.
Retained Earnings (Income Statement)
See net earnings.
Revenue
Synonyms: sales, sales revenue, turnover
Revenue includes both cash sales and credit sales of goods andservices but does not include the sale of fixed assets.
Sales
See revenue.
Selling Cost Ratio
Selling costs / Sales. This margin shows how much it costs to sell eachdollar of sales.
SG&A (Selling, General, and Administration)
Operational expenses that include direct and indirect selling expensesand all general and administrative expenses. Rent, heat, lights are allexamples of general expenses.
Share Capital
See capital stock.
Share Premium
See contributed surplus.
Shareholders’ Equity
See equity for the definition of Shareholders’ Equity.
Shares
See capital stock.
Statement of Earnings
See income statement.
Stock
See capital stock for the definition of stock.
Stock Repurchases
When a corporation buys back its own shares in the open market.
Tangible Fixed Assets
Synonyms: capital assets
Tangible Fixed Assets are fixed assets that have a physical presence andinclude things like land, buildings, machinery, equipment, computers, and so on.
Tax Expense
The tax liability that companies, and individuals, are required to pay bylaw.
Tax Ratio
Tax / Sales. This financial analysis ratio shows how well management ismanaging tax.
Turnover
See revenue.
Turnover Ratio
Financial analysis ratios that measure an assets’ activity or efficiency in generatingrevenues or cash. Total assets / Sales.
Work OverheadRatio
Direct overhead / Sales. Cost of goods sold is made up of labor, materials, and direct costs. This financial analysis ratio shows the proportion of direct overhead that goes to make up each dollar of sales.
Working Capital
Working Capitalis normally defined as money tied up in the day-to-day operations of an organization. It is approximately equal to current assets less current liabilities. However, many analysts will define working capital more explicitly as inventory and accounts receivable less accounts payable (and exclude other current assets).
Additional Resources
Thank you for reading CFI’s list of terms and definitions of the most common financial analysis ratios glossary. As an analyst calculating financial ratios, it’s critical to have a good understanding of basic terms. The information in this glossary is from CFI’s Financial Analysis Fundamentals Course.
- Analysis of Financial Statements
- Financial Modeling Guide
- Types of Financial Models
- Financial Modeling Analyst Certification
- See all accounting resources
- See all capital markets resources
As an expert and enthusiast, I have access to a wide range of information and can provide insights on various topics, including financial analysis and business decision-making. I can help explain important terms and definitions related to financial ratios. Here are some key concepts from the article you provided:
Accounts Payable
Accounts Payable refers to the amount owed by an organization to others for goods or services received. When a business buys from suppliers on credit, it generates accounts payable [[1]].
Accounts Receivable
Accounts Receivable is the amount due to an organization for goods delivered or services rendered. When a business sells to customers on credit, it generates accounts receivable [[2]].
Accounts Payable Days Ratio
The accounts payable days ratio is calculated by dividing accounts payable by the cost of goods sold (COGS) and then multiplying the result by 365. This ratio represents the average number of days it takes for a firm to pay for items purchased [[3]].
Accounts Payable Turnover
The accounts payable turnover ratio is calculated by dividing the cost of sales by accounts payable (either the ending balance or average balance). This ratio measures how effectively a company manages its payments to suppliers [[4]].
Accounts Receivable Days Ratio
The accounts receivable days ratio is calculated by dividing accounts receivable by sales and then multiplying the result by 365. This ratio represents the average number of days it takes for a firm to collect payments on goods sold [[5]].
Accounts Receivable Turnover
The accounts receivable turnover ratio is calculated by dividing sales by accounts receivable (either the ending balance or average balance). This ratio measures how effectively a company's credit and collection policies are in place [[6]].
Acid Test
The acid test is another term for the quick ratio. It is a financial ratio that measures a company's short-term liquidity by excluding inventory from current assets [[7]].
Administration Cost Ratio
The administration cost ratio is calculated by dividing administration costs by sales. This ratio shows the general overhead cost for each dollar of sales [[8]].
Amortization
Amortization refers to the gradual reduction of a financial amount over time [[9]].
Assets
Assets are resources owned and employed by an organization that confer future economic benefits. They can include tangible assets such as property and equipment, as well as intangible assets such as patents and trademarks [[10]].
Asset Turnover Ratio
The asset turnover ratio is calculated by dividing sales by total assets. This ratio shows how effectively a company generates sales from its assets [[11]].
Audit
An audit is the process of examining and verifying a firm's books of account, transaction records, and other relevant documents, including financial models [[12]].
Average Balance
The average balance is calculated by subtracting the closing balance from the opening balance and then dividing the result by 2. This balance can be used to calculate efficiency/turnover ratios instead of using a closing balance [[13]].
Balance Sheet
The balance sheet is a snapshot of an organization's assets and liabilities on a particular date. It shows the sources of funds provided to an organization and how those funds have been used to invest in fixed assets and working capital [[14]].
Capital
Capital refers to the funds provided to an organization in the form of equity or debt. It represents the financial resources used to finance the organization's activities [[15]].
Capital Asset
Capital assets, such as property, plant, and equipment, are employed to generate income [[16]].
Capital Employed
Capital employed represents the funds provided to an organization in the form of equity or debt. It is the total capital used by a company to finance its operations [[17]].
Capital Stock
Capital stock refers to the shares or stock issued by a company. There are two types of stock: common stock and preferred stock. Common stock generally carries one vote per share and an equal right to a proportionate share of dividends [[18]].
Cash Flow Statement
The cash flow statement is a financial statement that shows an organization's sources of cash during a financial year and how that cash has been used [[19]].
Circular References
Circular references occur when a formula includes a reference to the cell in which the formula appears [[20]].
Cost of Goods Sold (COGS)
Cost of goods sold refers to the direct costs associated with producing or purchasing the goods sold by a company [[21]].
These are just a few of the terms and definitions related to financial analysis ratios. If you have any specific questions or need further clarification on any of these concepts, feel free to ask!