Glossary of Financial Terms & Ratios for Entrepreneurs

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1 Glossary of Financial Terms & Ratios for Entrepreneurs TERM DEFINITION Capital Expenditure Accounts Payable Accounts Receivable Accrual Accounting Asset Balance Sheet Break-Even Point Business Plan Capital A capital expenditure (capex) is money invested by a company to acquire or upgrade fixed, physical, non-consumable assets, such as buildings and equipment or a new business. This represents what a business owes to its suppliers and other creditors at a given point in time. This represents the amount due to a business by its customers at a given point in time. A method of bookkeeping in which income and expenses are allocated to periods to which they apply, regardless of when actually received or paid. For example, when an invoice is rendered, its value is added to income immediately, even though it has not been paid. Anything -- tangible or intangible -- with commercial value owned by a business, such as equipment, receivables or goodwill. Financial report that shows the status of a company s assets, liabilities and owners equity. The point at which sales equal total costs. A written document that gives an overview of your company, its future and its financials. It explains what your business is now, what you plan to make itinto in the future, how you re going to do it, how much it will cost and how much you ll make. A business plan includes a description of your company, your products and services, your target market, your sales and marketing strategy, your financial documents, and your management team. Funds necessary to establish or operate a business. Capital Asset An asset that is purchased for long-term use such as machinery and equipment. Cash Accounting The simplest form of accounting in which income is considered earned when received and expenses are not taken into account until paid.

2 TERM DEFINITION Cash Flow Cost of Goods Debt Financing Movement of money into and out of a company; actual income received and actual payments made out. The cost of the materials to produce the products you sell or the cost of the product you are going to resell. Raising funds for a business by borrowing, often in the form of bank loans. Debt Service Depreciation Due Diligence Equity Cash payments covering interest charges and principal due on outstanding loans. Your debt service is the amount of money you have to pay each period (month/ year) to make your loan payments. Decrease in the value of equipment over time. Depreciation of equipment used for business is a tax-deductible expense. Process undertaken by venture capitalists, investment bankers or others to thoroughly investigate a company before financing it; required by law before securities are offered for sale. Shares of stock in a company; ownership interest in a company. Equity Financing Fixed Cost Income Statement Leverage Liability This involves selling a portion of your company to an outside investor. You have no obligation to repay the funds. In general, venture capital firms provide this type of funding. A production cost which does not vary significantly with the volume of output. An example would be administrative costs. A listing of income, expenses, and the resulting net profit or loss. This is also called a Profit & Loss (P&L) Statement. Debt in relation to equity; a highly-leveraged company is one with a high proportion of long-term debt. Claim on the assets of a company.

3 Glossary of Financial Terms & Ratios for Entrepreneurs TERM DEFINITION Marginal Cost Additional cost associated with producing one more unit of output. Operating Expenses Overhead Day-to-day expenses of running a business, from payroll to rent to supplies and marketing. Business expenses not directly related to a particular good or service produced. Pro Forma Statements Profit & Loss (P&L) Statement Return on Equity Triple Net Variable Cost Financial projections for a specific time period in a standardized format. Businesses use pro forma statements for decision-making in planning and control, and for external reporting to owners, investors, and creditors. Pro forma statements can be used as the basis of comparison and analysis to provide management, investment analysts, and credit officers with a feel for the particular nature of a business s financial structure under various conditions. A listing of income, expenses, and the resulting net profit or loss. This is also called an income statement. Amount earned on an equity investment in a given period; expressed as a percentage, and plotted over time to express how well investors money is being used. Rental type in which the tenant pays rent to the landlord and additionally assumes all costs regarding the operation, taxes and maintenance of the premises and building. Any costs which change significantly with the level of output. Venture Capital Working Capital Money used to support new or unusual undertakings; equity, risk or speculative investment capital. This funding is provided to new or existing firms which exhibit potential for above-average growth. The capital of a business that is used in its day-to-day operations, calculated as the current assets minus the current liabilities.

4 RATIO FORMULA DEFINITION Accounts Receivable Turnover Annual Inventory Turnover Net (credit) Sales/ Average Accounts Receivable Cost of Goods Sold for the Year/Average Inventory Gives a measure of how quickly credit sales are turned into cash. Alternatively, the reciprocal of this ratio indicates the portion of a year s credit sales that are outstanding at a particular point in time. Shows how efficiently the company is managing its production, warehousing, and distribution of product, considering its volume of sales. Higher ratios over six or seven times per year are generally thought to be better, although extremely high inventory turnover may indicate a narrow selection and possibly lost sales. A low inventory turnover rate, on the other hand, means that the company is paying to keep a large inventory, and may be overstocking or carrying obsolete items. Cash to Total Assets Cash/Total Assets Measures the portion of a company s assets held in cash or marketable securities. Although a high ratio may indicate some degree of safety from a creditor s viewpoint, excess amounts of cash may be viewed as inefficient. Cash Turnover Cost of Sales to Payables Current Ratio Days Receivable Ratio Net Sales/Net Working Capital Cost of Sales/ Accounts Payables Current Assets/ Current Liabilities 365/Sales to receivables ratio Reflects the company s ability to finance current operations, the efficiency of its working capital employment, and the margin of protection for its creditors. A high cash turnover ratio may leave the company vulnerable to creditors, while a low ratio may indicate an inefficient use of working capital. In general, sales five to six times greater than working capital are needed to maintain a positive cash flow and finance sales. Measures the annual turnover of accounts payable. Lower numbers tend to indicate good performance, though the ratio should be close to the industry standard. Measures the ability of an entity to pay its near-term obligations. Current usually is defined as within one year. Though the ideal current ratio depends to some extent on the type of business, a general rule of thumb is that it should be at least 2:1. A lower current ratio means that the company may not be able to pay its bills on time, while a higher ratio means that the company has money in cash or safe investments that could be put to better use in the business. Measures the average number of days that accounts receivable are outstanding. This number should be the same or lower than the company s expressed credit terms. Debt Ratio Debt/Total Assets Measures the portion of a company s capital that is provided by borrowing. A debt ratio greater than 1.0 means the company has negative net worth, and is technically bankrupt. This ratio is similar, and can easily be converted to, the debt to equity ratio.

5 Glossary of Financial Terms & Ratios for Entrepreneurs RATIO FORMULA DEFINITION Debt to Equity Ratio Debt/Owners Equity Indicates the relative mix of the company s investor-supplied capital. A company is generally considered safer if it has a low debt to equity ratio that is, a higher proportion of owner-supplied capital though a very low ratio can indicate excessive caution. In general, debt should be between 50 and 80 percent of equity. Gross Profitability Interest Coverage Inventory Holding Period Inventory to Assets Ratio Gross Profits/Net Sales Earnings before Interest, Taxes, and Depreciation/Interest Expense 365/Annual Inventory Turnover Inventory/Total Assets Measures the margin on sales the company is achieving. Indicates how comfortably the company can handle its interest payments. In general, a higher interest coverage ratio means that the small business is able to take on additional debt. This ratio is closely examined by bankers and other creditors. Calculates the number of days, on average, that elapse between finished goods production and sale of product. Shows the portion of assets tied up in inventory. Generally, a lower ratio is considered better. Net Profitability Net Income/Net Sales Measures the overall profitability of the company, or how much is being brought to the bottom line. Strong gross profitability combined with weak net profitability may indicate a problem with indirect operating expenses or non-operating items, such as interest expense. In general terms, net profitability shows the effectiveness of management. Though the optimal level depends on the type of business, the ratios can be compared for firms in the same industry. Quick Ratio Return on Assets Return on Investment Quick Assets (cash, marketable securities, and receivables)/ Current Liabilities Net Income/Total Assets Net Income/Owners Equity Also known as an acid test. Provides a stricter definition of the company s ability to make payments on current obligations. Ideally, this ratio should be 1:1. If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable. If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations. Indicates how effectively the company is deploying its assets. A very low return on asset, or ROA, usually indicates inefficient management, whereas a high ROA means efficient management. However, this ratio can be distorted by depreciation or any unusual expenses. Indicates how well the company is utilizing its equity investment. Due to leverage, this measure will generally be higher than return on assets. ROI is considered to be one of the best indicators of profitability. It is also a good figure to compare against competitors or an industry average.

6 Glossary of Financial Terms & Ratios for Entrepreneurs RATIO FORMULA DEFINITION Sales per Employee Sales to Receivables Total Sales/Number of Employees Net Sales/Accounts Receivable Can provide a measure of productivity. This ratio will vary widely from one industry to another. A high figure relative to one s industry average can indicate either good personnel management or good equipment. Also known as turnover ratio. Measures the annual turnover of accounts receivable. A high number reflects a short lapse of time between sales and the collection of cash, while a low number means collections take longer. Because of seasonal changes this ratio is likely to vary. As a result, an annual floating average sales to receivables ratio is most useful in identifying meaningful shifts and trends.

7 NOTES: Main tel Main fax St. Louis 7733 Forsyth Blvd. Suite 1200 St. Louis MO St. Charles 2460 Executive Drive St. Charles MO 63303

8 About Mueller Prost Mueller Prost is a leading team of CPAs and business advisors headquartered in St. Louis, MO that is to help clients grow and prosper. As a member of the PKF North America network (association of independent CPA firms), the firm has the ability to leverage national and global resources when needed to benefit client engagements. For more information, visit Main tel Main fax St. Louis 7733 Forsyth Blvd. Suite 1200 St. Louis MO St. Charles 2460 Executive Drive St. Charles MO California 4541 East Anaheim St. Long Beach CA 90804

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