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Key Financial Terms

TermDescription and DefinitionComments and Significance
Balance SheetThe statement of the company’s assets and liabilities at a given “snapshot” in time. It is prepared with the Income Statement and Cash Flow Statement.This is the part of the company’s quarterly, half yearly, and annual results that shows you the company’s health in terms of assets and liabilities. The company may have increased profits, but has it achieved this by increasing its financial leverage (i.e. more borrowings), and are these borrowings at a healthy level?
Cash FlowThis is net earnings before depreciation, amortization, and non-cash charges. Cash Flow is calculated by adding depreciation to net earnings and subtracting preference share dividends. Cash Flow is one of the ultimate ways of determining the health of a company.A profitable company can still go bust. Why? Because it isn’t generating enough cash. Young companies often have negative cash flows. Just look at a selection of Internet companies for examples. Many of these companies aren’t even profitable and will never be, let alone their ability to generate cash.
  Remember that a company needs CASH to pay its bills. If it cannot pay its bills, it will go bust. Cash Flow is an extremely important figure, but as with all of these figures, don’t just look at it in isolation.
  You need to check it with some of the other figures. For example, a new start-up with negative cash flow may look very unhealthy on the surface. But you might find that it has millions tucked away in cash and cash equivalents. Many of the Internet start-ups have survived in this way up to now, even in spite of their weak business models. It was only a matter of time for many of them!
Cash Flow StatementShows the cash position of the company.Remember we distinguished between profitability and liquidity. Cash Flow is influenced not only by revenues and expenses, but also by the company’s operating, investment, and financing decisions.
Current AssetsThese are assets that can be easily converted to cash within 12 months. Current Assets include cash, marketable securities, debtors, (accounts receivable) and inventory (stocks, UK translation).Current Assets are another measure of the immediate health of a company. A healthy sign is where Current Assets exceed Current Liabilities, since this demonstrates the company’s ability to pay its bills.
Current LiabilitiesThese are obligations that must be paid by the company within 12 months. These include short-term creditors (Accounts Payable), short-term debt, principal and interest on long-term debt. 
Deferred TaxesDeferred Taxes arise when a company makes provision for future (deferred) tax liabilities. Such provision is necessary because of timing differences between accounting profits and taxable profits. An example of a timing difference includes losses carried forward, in which case these would be stated as a deferred tax asset. 
DepreciationAn accounting term and non-cash charge imposed on companies to reflect the reduction in value of their fixed assets (that is, properties, computer equipment, plant, and machinery) in a designated fashion.Depreciation is purely an accounting phenomenon. Assets are depreciated every year according to the Depreciation policy of the individual company. The problem is that Depreciation is subtracted from profits, so a company that relies heavily on investment into Fixed Assets (with the exception of real estate assets, which may be reassessed to market value) can suffer diminution of profits because of high Depreciation charges. This is why it is important to look at the Cash Flow.
DividendsThe cash payment made by the company per ordinary share periodically during the year. In the UK this is often twice per annum, and in the USA each quarter.Dividends constitute the element of profit that the company does not reinvest back into itself. Dividends can be considered a reward to the ordinary shareholders for the risk they take in holding common stock. Shareholders will pay income tax with respect to their dividend income.
Earnings per Share (EPS)Total earnings divided by the number of outstanding common shares (issued ordinary share capital).As mentioned earlier, from a shareholder’s perspective, this is more important than the overall earnings figure.
EBITDA (or Operating Cash Flow)Earnings before interest, taxes, depreciation, and amortization.EBITDA is calculated by subtracting cost of sales and operating expenses from revenues. It can be a useful indicator in highlighting Cash Flow for companies with large investment projects where depreciation and amortization have dented the earnings figures.
Free Cash FlowThis is cash not required for operations or for reinvestment. Free cash flow is calculated by subtracting capital expenditure (capex) from cash flow. Capex includes investment in new plant and machinery, property, and equipment.Free Cash Flow can be used to pay dividends, pay off debt, or buy back stock. In some cases it can be used for a takeover war chest, although many fund managers have misgivings over this and would rather that Free Cash Flow be utilized for dividends or stock repurchases.
Income Statement (Profit and Loss Account)This is the company’s Earnings or Profits Statement within its quarterly, half yearly, and annual reports.This is the earnings report analysts and investors pay most attention to when evaluating the attractiveness of the stock.
Interest CoverMeasures the company’s ability to pay its interest charges on its debt. Calculated by dividing net earnings before interest and taxes by the interest expense on all long-term debt.Look for high Interest Cover since this will demonstrate that the company will be able to easily cover its interest payments. Failure to pay its debt-interest obligations could result in the company’s creditors calling in their loans and winding up the company.
Inventory (Stocks, UK translation)The value of the company’s raw materials, work in progress, and finished goods.Inventory cannot really be judged in isolation. You really need to compare current figures with those of the past to see if any trends are forming. High inventory could suggest that goods are not being sold fast enough. Low inventory could either indicate faster sales growth or production difficulties.
Long-term LiabilitiesDebt that is expected to be repaid after 12 months from the last balance sheet date.Long-term debt can include simple bank debt, mortgages, or bonds.
Market Capitalization (market value)The value of the company, as determined by the market at any given moment in time. This fluctuates with the price of the stock.Market cap is calculated as follows:No. of Shares x Share Price
Minority InterestThe part of a subsidiary company’s shareholders’ funds that is not owned by the parent company. This is usually shown as a separate item on the consolidated balance sheet. 
Net Earnings (Net Profit)The company’s revenues less all expenses including depreciation, taxes, and amortization.“Earnings” is principally an accounting figure because of the non-cash inclusions within its calculation. This is why we also rely on EBITDA.
Net EPSNet earnings divided by the number of shares of common stock. The number of shares is adjusted to reflect the conversion into equity of all securities which potentially can be converted, hence dilute the shareholding.Net EPS increases the number of shares to reflect the possibility of share dilution (described earlier) as contained within the company’s capital structure. Therefore, all employee company stock options are assumed to be fully converted into equity, as are any convertible loans, bonds, and so on.
Ordinary Shares/Common StockThese are the shares that make up the market value of the company. These shares typically have equal voting rights and are the main source of equity finance for corporations. These are the shares that you see traded on the NYSE or Nasdaq or LSE.Some companies pay a dividend with respect to each ordinary share.The number of ordinary shares multiplied by the value per share equals the market capitalization of the company.Ordinary shareholders are at the bottom of the pecking order if the company folds. Ordinary shares carry with them more risk, but also more potential reward.
Preference SharesThese shares are issued by corporations for cash, and have preferential rights over ordinary shares. This means that in the event of the company liquidating, the preference shareholders will be in front of ordinary shareholders in the pecking order.Preference shares are redeemable by the company at par either at the holder’s or company’s option. The company issues them and pays a fixed rate of return on them until redemption. The return is lower than for ordinary shareholders as is the risk. Preference shares act far more like bonds or debt instruments and as such many people believe they should be considered as debt, not equity.
Revenues (Turnover)Includes all net sales and turnover of the company, which form part of the main operations of the company.Revenues do not include dividends paid to the company, interest payments due to the company or any non-operating income.
Share PriceThe value of each individual share of a company, as determined by the market at any given moment in time. 
Share SplitThis is where a company decides to increase the number of shares in order to enhance the liquidity of the shares for its investors.The net effect is that investors will end up with more shares, although the share price will obviously be revalued downward to take this into account. All in all, the net effect is theoretically zero difference, but the market generally takes a positive view on stock splits, and often the shares will increase in value prior to the actual split date.Typically, share splits are a sign of confidence by the company. A share split is often interpreted as reward for investors, and in a bull market it is commonplace to see the shares rise in price from the date of the announcement up to the point of the split itself.
Shareholders’ Equity (Shareholders’ Funds)This is the balanced figure on the balance sheet, signifying the Book Value of the company for the ordinary shareholders (common stock holders).Used in calculating the gearing ratio, this will be the same as the figure for Net Assets.
Net AssetsThis is the company’s total assets less its total liabilities, also known as book value.This figure should be positive! Shareholders’ Equity represents the shareholders’ ownership of the company in terms of its Book Value.
Shares Outstanding (Issued Share Capital)These are the shares that are currently owned by investors.A company may have more shares than those that are already owned, and these form part of the company’s authorized share capital. Only issued shares (outstanding shares) form part of the company’s market value, and it is only the outstanding shares that we use in calculating the key financial ratios.
Total AssetsTotal Assets include all short-term (current) assets (that is, cash, debtors, readily convertible securities) and fixed assets (property, plant and machinery, and investments).Needs to be compared against itself over previous years and against liabilities for a meaningful insight to be made.
Total LiabilitiesInclude all short-term (current) liabilities (short-term creditors, overdrafts) and long-term debt and deferred taxes.Needs to be compared against itself over previous years and against assets for a meaningful insight to be made.
Total ReturnThe stock price change plus dividends over a period of time.Obviously we want this to be high. We would compare this figure against the market and against the stock’s past performance.



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