Glossary
Abnormal Losses
Losses arising in business that should have been avoided.
Absorption Costing
The method of allocating all indirect manufacturing costs to products. (All fixed costs are allocated to cost units.)
Account
Part of the double entry records containing details of transactions for a specific item.
Accounts payable
A record of money owed by a business for goods and services.
Accounts receivable
A record of money owed to the business for goods and services that have been provided to its customers.
Accrual basis accounting
Accrual-basis accounting records financial events based on events that change your net worth (the amount owed to you less the amount you owe others). Standard practice is to record expenses with the incomes they are associated with. For example, your landlord would record an income event on the day your rent comes due (you owe it to him). He records an expense event when the fee owed to the rental agent comes due for your apartment that month (he owes it to the agent). The details of the actual cash flows and their timing are tracked by bookkeeping.
Accounting
The process of identifying, measuring and communicating financial information to enable informed judgements and decisions.
Accounting Cycle
The sequence in which data is recorded and processed until it becomes part of the financial statements at the end of the period.
Accounting Equation
The formula that is the basis of double-entry bookkeeping. Assets = Source of Funds – Liabilities
Therefore an increase in assets must be accompanied by an equal increase in the liabilities and/or capital. This is the reason a Balance Sheet balances.
Accounting Periods
The period of time used by the business to process it's accounts to produce reports such as the Profit and Loss report and the balance sheet. For example, a company may run its accounts on a monthly basis, and produce 12 sets of reports in one year.
Accounting Policies
Those principles, conventions, rules and practices applied by a business that specify how the effects of transactions and other events are to be reflected in its financial statements.
Accounts
Accounts (or Final Accounts) - This is a term used to refer to statements produced at the end of accounting periods, such as the trading and profit and loss account and the balance sheet. The term 'financial statements' is more commonly used.
Accountant’s Report
A report by a firm of accountants confirming that the annual accounts have been properly prepared. This is an alternative to an audit.
Accrual Accounting
An accounting method that tries to match the recognition of revenues earned with the expenses incurred in generating those revenues. It ignores the timing of the cash flows associated with revenues and expenses.
With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands.
An example is a sale on credit. The sale is entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when the cheque is actually written. The disadvantage of this method is that you pay tax on revenue before you've actually received it.
Accrual
The accruals process allows a business to adjust the monthly accounts for payments made in arrears. This process is the reverse of prepayments.
There are certain expenses that are paid quite some time after they have been used. Electricity is a good example. Whilst you are using electricity the cost is accruing. If the business does not account for these costs in the correct accounting periods that the expense is incurred then the account would be inaccurate.
In most cases the electricity bill is sent every three months. If your business receives an electricity bill in April for electricity it has used in January to March and it has not been accounted for in the accounts, the accounts for January to March will be inaccurate.
The profit in each of these months would have been overstated. To account for this correctly, the business would set up an Accruals account, which is a liability account - this is money that the business owes but has not yet paid.
Most businesses know from experience how much the quarterly electricity bill is likely to be. In view of this, a 1/3 of that quarterly electricity bill is allocated to the electricity expenses account for each month. The transactions would be a debit to the electricity account and a credit to the accruals account each month.
The profit and loss report will show an expense for electricity costs and the balance sheet will show an accruals balance as a liability. This will increase each month until the electricity bill is received.
Once the bill has been received there is no longer a liability, therefore the accrual can be reversed. To do this you would then debit the accruals account and credit the electricity account equal to the amount of the accrual, in order to clear down (reset to zero) the balance. Then finally, the actual amount for the electricity bill would be paid by a debit to the electricity account and a credit to the bank account.
Accruals Concept
The accruals concept is that profit is the difference between revenue and the expenses incurred in generating that revenue.
Accrued Expense
This is an expense for which the benefit has been received, but has not been paid for by the end of the period. Examples are electricity or telephone use which are billed quarterly It is included in the balance sheet under current liabilities as 'accruals'.
Accrued Income
Accrued income is normally from a source of income, outside of the main source of business income, such as rent receivable on an unused office that was due to be received by the end of the period, but which has not been received by that date. It is added to debtors in the balance sheet.
Accumulated Depreciation Account
This account is used to accumulate depreciation for balance sheet purposes. It is used in order to leave the cost (or valuation) figure as the balance in the fixed asset account. It is sometimes confusingly referred to as the 'provision for depreciation account'.
Acid Test Ratio
This shows that, provided creditors and debtors are paid at approximately the same time, a view might be made as to whether the business has sufficient liquid resources to meet its current liabilities. Also referred to as the Quick Ratio.
Acid Test Ratio = (Current Assets - Stock) ÷ Current Liabilities
This ratio is probably the most important business test of all. It is an attempt to indicate how easily a company could pay its debts without selling its stock. Stock is not always easy to sell. See Current Ratio for a comparison with the inclusion of stock.
Adverse Variance
A difference arising that is apparently 'bad' from the perspective of the organisation. For example, when the total actual materials cost exceeds the total standard cost due to more materials having been used than anticipated. Whether it is indeed 'bad' will be revealed only when the cause of the variance is identified. It may, for example, have arisen as a result of an unexpected rise in demand for the product being produced.
AER
Stands for Annual Equivalent Rate. See What is AER, APR, EAR Interest for detailed information.
Aged Debtors
Debtors who have owed money to the business for a defined period of time.
Aged Debtors Analysis
A report that analyses amounts owed by customers according to the length of time that those amounts have remained unpaid. For example, all customers who have outstanding invoices that are over a month old.
Allocation
The process of matching payments against purchase invoices and receipts against sales invoices raised.
Amortisation
Spreading the cost of an intangible asset, such as a lease, over the years in which it is used. It is usual to divide the cost of the lease by the number of years that the lease is held for, and then use that figure as the annual charge. This is similar to depreciation except that depreciation deals with tangible or fixed assets such as motor vehicles or plant and equipment.
Analysis
A breakdown or summary of what is included in a figure in the accounts.
Annual Report and Accounts
A document containing the financial statements and Directors’ Report.
Annuity
An income-generating investment whereby, in return for the payment of a single lump sum, the annuitant receives regular amounts of income over a predefined period.
Annulment
Cancellation usually of a bankruptcy.
Appropriation Accounts
These show the way that net profit is distributed (usually in the form of cash dividends) between partners in a partnership or between shareholders and reserve funds in a company.
APR
Stands for Annual Percentage Rate. Please see What is AER, APR, EAR Interest for detailed information.
Arbitration
In arbitration an independent third party considers both sides in a dispute, and makes a decision to resolve it. The arbitrator is impartial, means he or she does not take sides. In most cases the arbitrator's decision is legally binding on both sides, so it is not possible to go to court if you are unhappy with the decision.
Most types of arbitration have the following in common:
- Both parties must agree to use the process
- It is private
- The decision is made by a third party, not the people involved
- The arbitrator often decides on the basis of written information
- If there is a hearing, it is likely to be less formal than court
- The process is final and legally binding
- There are limited grounds for challenging the decision
Articles of Association:
For UK limited companies. This is the document that arranges the internal relationships, for example, between members of the company, and the duties of directors. The Companies Act 1985 gives a model known as Table A.
Assets
Generally, an asset is something that is of value to a company. An asset can then be broken down further into Tangible and Intangible assets.
Examples of tangible assets include property, vehicles, stock, cash, money held in the bank and Debtors (as they owe money from sales made by the company).
However, these can be broken down still further into Fixed Assets and Current Assets Examples of intangible assets include patents, copyrights, trademarks and goodwill. While these may not have value to the man on the street, these generate income for the company.
Auditor
A person qualified to inspect, correct and verify business accounts.
Audit Trail
A register of the details of all accounting transactions. This register shows how a transaction was dealt with from start to finish.
Authorised (Or Licensed) Insolvency Practitioner
The person (usually an accountant or solicitor) or a recognised professional body formally authorised to act as trustee, nominee, supervisor, liquidator, administrative receiver or administrator.
Authorised Share Capital
The total value of shares that the company could issue, as distinct from the up and paid up share capital.
Bad Debt
A Bad Debt arises when a person or company is not expected to pay the debt. For example, because the company has gone into liquidation. Bad debts must be written-off and therefore they will reduce profit.
A bad debt becomes a bad debt when a business decides it is one. The decision is often based on past experience. Decisions are made by keeping a list of all debtors (aged debtors) and reviewing this list periodically.
If a business is having difficulties collecting money owed from one of its customers it may decide to cancel the debt. This is called a write-off and the accounts would need to be adjusted for this write-off.
Balance Brought Down
The difference between both sides of an account that is entered below the totals on the opposite side to the one on which the balance carried down was entered. (This is normally abbreviated to 'balance b/d'.)
Balance Carried Down
The difference between both sides of an account that is entered above the totals and makes both sides equal to each other. (This is normally abbreviated to 'balance c/d'.)
Balance Sheet
A report that details the various assets and liabilities of a business at a point in time, usually the end of an accounting period. A Balance Sheet must always balance, i.e. debits must always equal the credits.
Bank Cash Book
A cash book that only contains entries relating to payments into and out of the bank.
Bank Giro Credit
An amount paid by someone directly into someone else's bank account.
Bank Loan
An amount of money advanced by a bank that has a fixed rate of interest that is charged on the full amount, and is repayable by a specified future date.
Bank Reconciliation
The process of matching transaction from accounting records against those presented on a bank statement. The accounting ledger should reconcile (match) to the balance of the bank statement. Bank reconciliation will reveal any possible discrepancies.
Bank Reconciliation Statement
A calculation comparing the Cash Book balance with the bank statement balance.
Bank Statement
A record of bank account transactions issued by a bank to a customer
Bankrupt
A person, firm, or corporation that has been declared insolvent through a court proceeding and is relieved from the payment of all debts after the surrender of all assets to a court-appointed trustee.
Bankruptcy Order
The court order making an individual bankrupt.
Bankruptcy Petition
A written application to Court by either a debtor or his creditors applying for an order to be made for the debtor to be made bankrupt.
Bonus Issue
A bonus share is a free share of stock given to current/existing shareholders in a company, based upon the number of shares that the shareholder already owns at the time of announcement of the bonus. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant.
Whenever a company announces a bonus issue, it also announces a “Book Closure Date” which is a date on which the company will ideally temporarily close its books for fresh transfers of stock. An issue of bonus shares is referred to as a bonus issue.
Depending upon the constitutional documents of the company, only certain classes of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to other classes.
Bonus share is free share in fixed ratio to the shareholders.
Sometimes a company will change the number of shares in issue by capitalising its reserve. In other words,it can convert the right of the shareholders because each individual will hold the same proportion of the outstanding shares as before. Main reason for issuance is the price of the existing share has become unwieldy.
Also known as a “scrip issue” or “capitalization issue”.
Bonus Shares
Shares issued to existing shareholders free of charge. (Also known as scrip issues.) Book Keeping The process of recording the day to day accounting transactions of a business.
Book value
The book value of an asset or group of assets is the price at which they were originally acquired (usually the purchase price). Book value forms the basis of various calculations e.g. of nominal capital gains (current value divided by book value), of amortized value (book value adjusted for depreciation).
Break-Even
Point The level of activity at which total gross profit equals total costs.
Bought Ledger
Another name for Purchase Ledger. This is where the individual accounts of creditors for goods and services are kept in a single ledger.
Budget
A forecast of expected income or expenditure over a specified period of time.
Budget Variance
The difference between the expected and actual amount for income or expenditure.
Business Entity Concept
Assumption that only transactions that affect the business and not the owner's private transactions will be recorded.
Business-To-Business (B2B)
Businesses purchase from other businesses and/or sell their goods and services to other businesses.
Business-To-Customer (B2C)
Businesses which sell to consumers.
See Construction Industry Scheme
CVA (Company Voluntary Arrangement)
The CVA is a form of composition, similar to the personal IVA (Individual Voluntary Arrangement), where an insolvency procedure allows a company with debt problems or insolvent to reach a voluntary agreement with its business creditors to repay all or part of its corporate debts over an agreed period of time. A Company Voluntary Arrangement (CVA) can be applied for by the agreement of all directors of the company, the legal administrators of the company, or the appointed company liquidator.
A company voluntary arrangement can only be implemented by an insolvency practitioner who will draft Proposal for the creditors. A meeting of creditors is held and if 75% (by debt value) of the creditors who vote agree then the CVA is accepted. All the company creditors are then bound to the terms of the proposal whether or not they voted. Creditors are also unable to take further legal actions as long as the terms are adhered to, and existing legal action such as a Winding Up Order ceases.
During the CVA, payments are made in a single monthly amount paid to the insolvency practitioner. The fees charged by the insolvency practitioner will be deducted from these payments. The company is not required to fund any further costs.
Call
When shares are issued only part of their cost is usually paid at the time of application and allotment. A "call" is a demand by the company for part or all of the outstanding sums to be paid.
Called Up Share Capital
The face value of shares for which payment has been requested ("called up"). These payments may not necessarily be made.
Capital
In general, capital is the money invested in the business. Shareholder’s capital employed refers to share capital and reserves only, total capital employed includes long term loans.
Capital employed
The value of all resources available to the company, typically comprising share capital, retained profits and reserves, long-term loans and deferred taxation.
Viewed from the other side of the balance sheet, capital employed comprises fixed assets, investments and the net investment in working capital (current assets less current liabilities). In other words: the total long-term funds invested in or lent to the business and used by it in carrying out its operations.
Capital Expenditure
Money spent on the acquisition of an asset, such as premises, motor vehicles, plant or machinery that will be used within the business over a period of years.
Capital Gain
Profit made on selling an asset for more than its original purchase price.
Capital Gains Tax (CGT)
Tax paid on the profit made on selling an asset for more than its original purchase price, i.e. the capital gain.
Capitalisation
The way that a company’s capital is divided into share and loan capital. In this way they can then be released to the Profit and Loss report in instalments over the accounting periods to which they relate.
Capital Redemption Reserve
A 'non-distributable' reserve created when shares are redeemed or purchased other than from the proceeds of a fresh issue of shares.
Capital Reserve
An account that can be used by sole traders and partnerships to place the amount by which the total purchase price paid for a business is less than the valuation of the net assets acquired. Limited companies cannot use capital reserve for this purpose. Sole traders and partnerships can instead, if they wish, record the shortfall as negative goodwill.
Cash
Cash balances and bank balances, plus funds invested in 'cash equivalents'.
Cash Accounting
A scheme where VAT is paid on payments and receipts rather than the invoices that you raise. This scheme is available for small companies with a turnover below a given threshold. The cash method is the most simple in that the books are kept based on the actual flow of cash in and out of the business. Income is recorded when it's received, and expenses are reported when they're actually paid.
Cash accounting is used by many sole proprietors and businesses with no inventory. From a tax standpoint it is sometimes advantageous for a new business to use cash accounting. That way, recording income can be put off until the next tax year, while expenses are counted right away.
Cash Book
A book used to record details of cash moving in and out of the bank current account.
Cash Equivalents
Temporary investments of cash not required at present by the business, such as funds put on short-term deposit with a bank. Such investments must be readily convertible into cash or available as cash within three months.
Cash Flow
The movement of cash in and out of a business. Profitable businesses can still fail if customers pay more slowly than the business pays its suppliers, so cash flow should always be measured.
Cash Flow Forecast
A report which estimates the cash flow in the future (usually required by a bank before it will lend you money, or take on your account). A cash flow forecast is often used as part of a business plan.
Cash Flow Statement
A cash flow statement is a financial report that shows incoming and outgoing money during a particular period (often monthly or quarterly). It does not include non-cash items such as depreciation. This makes it useful for determining the short-term viability of a company, particularly its ability to pay bills.
UK companies, except the very smallest, have to publish a cash flow statement for each accounting period. The layout is regulated by FRS 1. This is a legal requirement, and should not be confused with a cash flow forecast. Cash Payment A transaction that reflects payment for goods or services where either no invoice has been raised and money is handed over immediately the goods have been received (e.g. buying petrol for a car), or when the invoice is paid as soon as it is received. This removes the need to post an invoice onto the purchase ledger and the transaction is entered through the cash book.
Cash Receipt
A transaction that reflects the receipt of money for goods or a service where either no invoice has been raised (e.g. selling goods over the counter and the money is handed over immediately the goods have been received) or the invoice is paid as soon as it is received thereby removing the need to post an invoice onto the Sales Ledger. Instead of the money being paid directly into the bank the money is paid into the Petty Cash account and entered through the cash book
Charge Card
A payment card that requires the cardholder to settle the account in full at the end of the specified period; e.g. American Express and Dinners cards. Holders usually have to pay an annual fee for the card.
Chart of Accounts
A list of all the nominal accounts used by a business. It is used to analyse income, expenditure, assets, liabilities and capital, together with the way such categories are assigned to the Balance Sheet or Profit and Loss report.
Cheque Book
Book containing forms (cheques) used to pay money out of a current account.
Clearing
The process by which amounts paid by cheque from an account in one bank are transferred to the bank account of the payee.
Closing Balance
The balance of an account at the end (or close),of an accounting period. This figure is then carried forward to the next accounting period.
Compound Interest
Compound Interest is calculated on the basis of the original sum together with interest earned from previous periods.
Consolidation Accounting
This term means bringing together the separate financial statements of a group of companies into a single balance sheet and profit and loss account. Hence they are known as group financial statements.
CIS (Construction Industry Scheme)
The Construction Industry Scheme (CIS) sets out the rules for how payments to subcontractors for construction work must be handled by contractors in the construction industry.
The scheme applies mainly to contractors and subcontractors in mainstream construction work, however businesses or organisations whose core activity isn't construction but have a high annual spend on construction may also count as contractors and fall under the scheme.
Company Voluntary Arrangement
See CVA
Contra Entry
An adjustment made to balance transactions in one ledger with another. The most common type of contra entry is balancing outstanding purchase ledger transactions against outstanding sales ledger transactions where you both sell to and buy from the same company.
For example: you have sold goods to XYZ to the value of £200. You have also bought goods from XYZ to the value of £100. Overall they owe you £100 (i.e. what they owe you less what you owe them). A contra entry matches up the £100 you owe them against £100 they owe you.
Contribution
The difference between sales income and marginal cost. It can also be defined as sales income minus variable cost.
Control Account
Accounts to which single balances analysed elsewhere in the accounting system are posted. Often the balances are posted from other ledgers. For example, the debtors control account records the amount of sales recorded in the sales ledger. It is reduced by receipts from customers also posted through the bank ledger.
Corporate Governance
The exercise of power and responsibility for corporate entities.
Corporation Tax
A tax levied on the profits of UK companies annually.
Cost of goods sold (COGS)
The directly attributable costs of products or services sold, (usually materials, labour, and direct production costs). Sales less COGS = gross profit. Effectively the same as cost of sales (COS) see below for fuller explanation.
Cost Of Sales
The direct costs incurred as a result of making sales. For a retail company, this may mean the cost of purchasing goods, net of carriage and purchasing discounts, less the movement in the value of the stock. For a manufacturing company, it may mean the cost of producing the goods sold.
Commonly arrived at via the formula: opening stock + stock purchased - closing stock. Cost of sales is the value, at cost, of the goods or services sold during the period in question, usually the financial year, as shown in a Profit and Loss Account (P&L).
In all accounts, particularly the P&L (trading account) it's important that costs are attributed reliably to the relevant revenues or the report is distorted and potentially meaningless. To simply use the total value of stock purchases during the period in question would not produce the correct and relevant figure, as some product sold may have already been held in stock before the period began, and some product bought during the period may remain unsold at the end of it. Some stock held before the period often remains unsold at the end of it too.
The formula is the most logical way of calculating the value at cost of all goods sold, irrespective of when the stock was purchased. The value of the stock attributable to the sales in the period (cost of sales) is the total of what we started with in stock (opening stock), and what we purchased (stock purchases), minus what stock we have left over at the end of the period (closing stock).
Credit
One side of the double-entry bookkeeping process, representing negative figures on the Balance Sheet (reductions in assets; increases in liabilities and capital), and income on the Profit and Loss report.
Credit Card
A card enabling the holder to make purchases and to draw cash up to a pre-arranged limit. The credit granted in a period can be settled in full or in part by the end of a specified period. Many credit cards carry no annual fee.
Credit Note
Sent from the seller to the customer in order to cancel or reverse all or part of an invoice.
Creditors
People and businesses who are owed money by the business.
Creditor / Purchases Ratio
A ratio assessing how long a business takes to pay creditors.
Current Account
A bank account used for regular payments in and out of the bank.
Current Asset
A current asset is an asset where the worth can be easily realised converted into cash within twelve months of the balance sheet date. It can also be termed a liquid asset. For example, money in the bank or in petty cash, debtors, prepayments, or stock.
Current Liability
A current liability is a debt owed by the company, for example, creditors, accruals or an overdraft that are due within the fiscal year.
Current Ratio
This compares assets, which will become liquid within approximately twelve months (i.e. total current assets) with liabilities which will be due for payment in the same period (i.e. total current liabilities) as is intended to indicate whether there are sufficient short-term assets to meet the short term liabilities.
Current Ratio = Current Assets ÷ Current Liabilities
This ratio is an indication of the ability of a business to pay its debts when they fall due. Sometimes a ratio of 2:1 is quoted as being average. What this means, is that for every £1 of current debt, there is £2 in current assets to meet that debt.
See Acid Test Radio for a comparision without the inclusion of stock.
A book that lists all transactions in the order that they arise. There is often a day book for different types of transaction, e.g. a sales day book and a purchase day book.
Debenture
The term debenture is used when a limited company receives money on loan, and certificates called debenture certificates are issued to the lender. Interest will be paid to the holder, the rate of interest being shown on the certificate. They are not always called debentures; they are often known as loan stock or as loan capital.
Debenture interest has to be paid whether profits are made or not. They are therefore different from shares where dividends depend on profits being made. A debenture may be either
- Redeemable, i.e repayable at or by a particular date, or
- Irredeemable, normally repayable only when the company is officially terminated by its going into liquidation. (Also sometimes referred to as 'perpetual' debentures)
Debit
Debit is an accounting and bookkeeping term that comes from the Latin word debere which means "to owe." The opposite of a debit is a credit. Debit is abbreviated Dr while credit is abbreviated Cr. A debit can be either a positive or negative entry to an account depending on what type of account is being debited. Asset and expense accounts increase in value when debited, whereas liability, capital, and revenue accounts decrease in value when debited.
Debit Card
A card linked to a bank or building society account and used to pay for goods and services by debiting the holders account. Debit cards are usually combined with other facilities such as ATM and cheque guarantee card functions.
Debit Note
A document sent to supplier showing allowance to be given for unsatisfactory goods.
Debt
Debt is money that is owed.
People or organisations often enter into agreements to borrow something. Both parties must agree on some standard of deferred payment. Usually a sum of money is denominated as the unit of currency, but sometimes a like good.
For example, shares might be borrowed and then repaid later with the shares plus a premium for borrowing, or the sum of money required to buy them in the market at that time.
There are numerous types of debt obligations. They include loans, bonds, mortgages, promisary notes, and debentures.
Debtors
People and businesses who owe your business money for goods or for services you have supplied.
Debtor/Sales Ratio
A ratio assessing how long it takes debtors to pay their debts.
Deferred Taxation
Timing differences arise between the accounting treatment of events and their taxation results. Deferred taxation accounting adjusts the differences so that the accounts are not misleading.
Deficit
A deficit is where more money has been spent than received by an organisation in a given period.
Depletion
The wasting away of an asset as it is used up.
Deposit Account
A bank account for money to be kept in for a long time. Deposit accounts normally pay a higher rate of interest when compared to a than current accounts.
Depreciation
A figure representing the reduction in value of a fixed asset through use, obsolescence etc, in the calculation of Net profit.
This involves dividing the value of the asset into instalments to each accounting period of its useful life.
Depreciation involves estimates of life and residual values. It is common that an asset will be worth less at the end of its life expectancy than when the business first started using it, so in affect, it has cost the business money. If it has cost the business money, then it must be an expense and will therefore affect the profit and loss. The asset is also expected to be worth less, and thus also affect the balance sheet.
There are various methods of depreciation, Straight Line and Reducing Balance:
Straight Line Depreciation Method
To use the Straight Line method, you need to know:
- The initial cost of an asset.
- The useful life of the asset and the residual value of the asset, (what it will be worth at the end of its useful life) or scrap value.
As an example, the business has a vehicle worth £10,000 that is expected to last 5 years and is estimated to be valued at £4,000 after that time. This means it will be worth £6,000 less in 5 years time and the £6,000 will be a cost to the business and therefore needs to be apportioned to the depreciation expense account. £6,000 divided by 60 months = £100 depreciation cost per month.
To account for this the business would set up a depreciation account as an expense account. A debit of £100 would be made to this account monthly and a credit would go to the vehicle account reducing the value of the asset each month. Using this method the value left in the vehicle account by the end of 5 years would be £4000.
Reducing Balance Depreciation Method
The other method of accounting for depreciation is called Reducing Balance. The asset is not reduced by the same fixed amount each year but instead by a fixed percentage, which is calculated on the asset balance at the end of each year once depreciation has been applied.
For example, let’s assume that a veehicle will depreciate by 20% every year over the life of 5 years:
Year 1 Original Cost Depreciation = £10,000 - £2,000
Year 2 Balance Depreciation = £8,000 - £1,600
Year 3 Balance Depreciation = £6,400 - £1,280
Year 4 Balance Depreciation = £5,120 - £1,024
Year 5 Balance Depreciation = £4,096 - £819
Balance = £3,277
As you can see, the depreciation for year 1 has been calculated as 20% of £10,000, but in year 2 the depreciation has been calculated as 20% of the reduced balance which is £8,000 - £1,600 depreciation in year 2 which differs from the depreciation amount in year 1.
Direct Costs
Costs that can be traced to the item being manufactured.
Direct Debit
An instruction from a customer to their bank or building society authorising an organisation to collect money from their account, as long as the customer has been given advance notice of the collection amounts and dates. The Direct Debit Scheme also protects you and your money by means of the Direct Debit Guarantee. All banks and building societies that take part in the Direct Debit Scheme operate this Guarantee. The efficiency and security of the Scheme is monitored and protected by your own bank or building society.
Direct Expenses
Those expenses that are incurred in the actual manufacture and sale of the product or the sale and provision of the service, i.e. the expenses incurred by the business actually trading. For example, the wages of the machine operators, the power to run the machines, the wages and commission of the sales staff, the cost of advertising and any sales promotions. Directors Officials appointed by shareholders to manage the company for them.
Discount
The amount by which a bill is reduced. Discounts can be given for a variety of reasons, e.g. buying in bulk, spending large amounts, trade discount, early settlement discount.
Dishonoured Cheque
A cheque which the drawer's bank has refused to allow payment.
Dissolution
When a partnership firm ceases operations and its assets are disposed of. Distributable Profits In company accounts these are the sums that are available for dividends to shareholders. While based on the net profit, they may be increased by undistributed profits from the previous year or reduced by the need to retain some for the reserves.
Dividend
A dividend is the distribution of profits to a company's shareholders.
When a company earns a profit, some of this money is typically reinvested in the business (retained earnings), and some of it can be paid to its shareholders as a dividend. Paying dividends reduces the amount of cash available to the business, but the distribution of profit to the owners is the purpose of the business.
The amount paid out per share. Usually described as a percentage of the face value (the original price) of one share. So a 10% dividend on a £2.00 share would be 20p.
Double Entry
A system of bookkeeping in which every transaction of a business is entered as a debit in one account and as a credit in another.
As every transaction must have an equal or zero effect on both sides of the accounting equation, every positive amount entered (debit) must be mirrored by a negative amount or amounts (credit).
Drawings
Cash or goods taken from the business for the owners’ personal use. Drawings only apply to sole traders and partnerships. Drawings do not count as an expense in the Profit and Loss account and must be included in the financed by section of the Balance Sheet.
EAR
Stands for Effective Annual Rate. Please see What is AER, APR, EAR Interest for detailed information.
EBITDA
EBITDA stands for "Earnings before Interest, Taxes, Depreciation, and Amortization".
When companies publish their financial statements, the most important metric for investors is the company's income, which is calculated as the company's revenue minus all its expenses. Some companies also publish their EBITDA, which, these companies usually claim, provides a more true picture of the company's profitability than the "income" number.
There are several 'Earnings Before..' ratios and acronyms: EBT = Earnings Before Taxes; EBIT = Earnings Before Interest and Taxes; EBIAT = Earnings Before Interest after Taxes; EBITD = Earnings Before Interest, Taxes and Depreciation; and EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization. (Earnings = operating and non-operating profits (eg interest, dividends received from other investments). Depreciation is the non-cash charge to the balance sheet which is made in writing off an asset over a period. Amortisation is the payment of a loan in instalments.
Economic Order Quantity (EOQ)
A calculation stating the amount of stock that should be ordered at a time, and how frequently to order it, so that the overall total of the costs of holding the stock and the costs of ordering the stock can be minimised.
Equity
The net assets of a company after all creditors have been paid off.
Expenses
Expenses are those items that the company buys which do not go to actually create that company’s product or service eg. stationery, petrol, promotional goods.
Factoring
Selling the rights to the amounts owing by debtors to a finance company for an agreed amount (which is less than the figure at which they are recorded in the accounting books because the finance company needs to be paid for providing the service).
FIFO
FIFO, or First In First Out, is an assumption that enables the cost of stock to be calculated. When sales are made the items sold are assumed to be the earliest purchased, so the cost of items in stock always reflect the most recent purchases.
Final Accounts
This is a term previously used to refer to statements produced at the end of accounting periods, such as the trading and profit and loss account and the balance sheet. Nowadays, the term 'financial statements' is more commonly used.
Finance Lease
This is an agreement whereby the lessee enjoys substantially all the risks and rewards associated with ownership of an asset other than legal title.
Financial Accounting Financial accounting is concerned with recording financial transactions that have already occurred and with providing information from the accounting records, for example in order to prepare VAT returns, and Trial Balance (the starting point for the preparation of the Profit and Loss Statement and Balance Sheet).
The main features of financial accounting are that it:
- Records transactions that have happened already
- Looks backwards to show what has happened in the past
- Is accurate to the nearest penny, with no estimated amounts
- Is often a legal requirement to keep accounts (in order to prepare VAT returns, and tax returns for the HM Revenue & Customs showing income and expenditure)
- Maintains confidentiality of information (e.g. payroll details, VAT returns)
Financial modelling
Manipulating accounting data to generate forecasts and perform sensitivity analysis.
Financial Statements
The more common term used to refer to statements produced at the end of accounting periods, such as the trading and profit and loss account and the balance sheet (sometimes referred to as 'Final Accounts' or simply 'The Accounts').
Fixed Assets
Assets which the business intends to retain for the coming year rather than convert into cash. Typical fixed assets include property, office equipment and motor vehicles. Assets which have a long life bought with the intention to use them in the business and not with the intention to simply resell them.
Fixed Capital
Accounts Capital accounts which consist only of the amounts of capital actually paid into the firm.
Fixed Costs
Expenses which remain constant whether activity rises or falls, within a given range of activity.
Float
The amount at which the petty cash starts each period.
Forecasting
Taking present data and expected future trends, such as growth of a market and anticipated changes in price levels and demand, in order to arrive at a view of what the likely economic position of a business will be at some future date.
Gearing
The ratio of long-term loans and preference shares shown as a percentage of total shareholders' funds, long-term loans, and preference shares.
General Ledger
A ledger for all accounts other than those for customers and suppliers. Also known as Nominal Ledger.
Going Concern Concept
The assumption that a business is to continue trading for the foreseeable future.
Goodwill
An intangible asset of a business reflecting its commercial reputation, customer connections, etc.
Gross
The total amount before any deductions.
Gross Loss
Where the cost of goods sold exceeds the sales revenue.
Gross Margin
A measure of the profitability of a business. It is calculated by dividing gross profit by sales and is usually expressed as a percentage.
Gross Profit
The difference between total revenue from sales and the total cost of purchases or materials, with an adjustment for stock.
Hire Purchase
Agreements Agreements by which an organisation can obtain the use of an asset and make payment by instalments.
Holding Company
The outdated term for what is now known as 'parent undertaking'.
IVA - Individual Voluntary Arrangement
The IVA was established by the Insolvency Act 1986. It constitutes a formal repayment proposal presented to a debtor's creditors via an Insolvency Practitioner. Usually (but not necessarily) the IVA compromises only the claims of unsecured creditors, leaving the rights of secured creditors largely unchanged.
An IVA is a contractual arrangement with creditors and can be as flexible as an individual's own circumstances. It can therefore be based on capital, income, third party payments or a combination of these.
Creditors take a decision at a creditors' meeting called to consider the IVA proposal. The return to creditors is often higher than they would receive in bankruptcy. A vote is taken - by value. More than 75% in value of those creditors who vote at the meeting by person or by proxy must agree in order for the arrangement to be approved. If any of those voting are 'associates' (usually business associates, friends and family) then a second count is taken and 50% of non-associated creditors must approve it.
In the UK, an increasing number of consumer debtors with overwhelming levels of debt are turning to specialist debt advice organisations that offer an alternative to bankruptcy via the use of an IVA.
An IVA is an alternative to bankruptcy, however they are not mutually exclusive. A person can propose an IVA after they have been made bankrupt. If an arrangement is approved post-bankruptcy then the debtor can apply to the Court for an annulment of the bankruptcy order - such IVAs can only be proposed whilst the bankrupt is undischarged. If an IVA is proposed after a bankruptcy order has been made, it is now also possible to nominate the Official Receiver to be the supervisor of the arrangement. The Arrangements offered by the Official Receiver are very restricted. This type of arrangement is called a Fast Track Voluntary Arrangement and is only suitable in certain cases.
Impersonal Accounts
All accounts other than debtors and creditors accounts.
Imprest System
A method of managing petty cash where the level of float required is set and money is replaced with receipts and/or petty cash vouchers as items are purchased. The total of the receipts/vouchers and cash should always equal the original float.
Income & Expenditure Account
An account for a non-profit-oriented organisation to find the surplus or loss made during a period.
Income OR Earning
In business and accounting, income (also known as profit or earnings) is the amount of money that a company earns after paying for all its costs.
To calculate a company's income, it starts with its amount of revenue, deducts all costs, including salaries and depreciation, and the resulting figure is its income.
Some of this money is typically reinvested in the business, and some of the money might be used to pay the owners (the shareholders) a dividend.
Income per share OR Earnings per share
Income per share is the bottom line net income divided by the number of shares outstanding. It is more often referred to and reported as earnings per share.
Income statement
Statement of revenue of a company less expenses incurred.
Incomplete Records
The term used for any system of bookkeeping which does not use full double entry.
It generally applies to small business whether incorporated (see Limited Company) or sole trader or partnership. For them, generally a simple cashbook to record receipts and payments may be enough instead of the proper accounting system complete with daybooks and ledgers.
Using incomplete records cannot give an accurate set of accounting period end financial statements, as they do not tell the whole story. There is no record of outstanding debtors or creditors, or of stock. No analysis of what receipts and payments have been received and paid, or, in some cases, of the split between revenue and capital items.
In an incomplete record system, the figures must be calculated, extrapolated (or extracted in the case of creditors and debtors) to arrive at the year-end profit and loss account.
As a result the balance sheet will rely heavily on application of the concept of the accounting equation. Thus the value of capital can be determined at any point in time.
Independent Examination
External examination of the accounts of a charity by someone independent of the organisation. This is available instead of a full audit for charities with income below £250,000, although it is not required if income is below £10,000. An independent examiner must be an individual and must be competent to carry out the examination. The Charity Commission gives guidance that should be followed in completing an examination.
Indirect manufacturing costs
Costs relating to manufacture that cannot be economically traced to the item being manufactured (also known as 'indirect costs' and sometimes, as 'factory overhead expenses'). Input Tax VAT added to the net price of inputs (i.e. purchases).
Individual Voluntary Arrangement (IVA)
See IVA
Inputs
Purchases of goods and services. Insolvent When liabilities are greater than assets.
Intangible Assets
intangible assets include copyrights, patents, goodwill, etc., they are saleable but do not contain any intrinsic productive value.
Interest
A charge made on a loan or money received on a capital investment.
Interest On Capital
An amount at an agreed rate of interest which is credited to a partner based on the amount of capital contributed by him/her.
Interest On Drawings
An amount at an agreed rate of interest, based on the drawings taken out, which is debited to the partners.
Initial Public Offering (IPO)
An Initial Public Offering (IPO being the Stock Exchange and corporate acronym) is the first sale of privately owned equity (stock or shares) in a company via the issue of shares to the public and other investing institutions.
IPOs typically involve small, young companies raising capital to finance growth. For investors IPO's can risky as it is difficult to predict the value of the stock (shares) when they open for trading. An IPO is effectively 'going public' or 'taking a company public'.
Inventory
Usually refers to stock held
Investment
Investment is a term with several closely related meanings in finance and economics. It refers to the accumulation of some kind of asset in hope of getting a future return from it. Invoice Sent out by the seller or service provider to request payment for goods or services.
Job Costing
A costing system that is applied when goods or services are produced in discrete jobs, either one item at a time, or in batches.
Joint Ventures
Business agreements under which two businesses join together for a set of activities and agree to share the profits.
Journal
A book in which an account of transactions is kept previous to a transfer to the ledger.
Journal Entries
Double-entry transactions not raised through the cash book or individual ledgers. Sometimes referred to as a 'Journal'.
Ledgers
The principal book in which the transactions of a business are recorded. The details of customers and their transactions are recorded in the sales ledger. Suppliers and their transactions are recorded in the purchase ledger.
All ledgers are amalgamated in the nominal ledger by posting balances from the individual ledgers. The nominal ledger also receives postings from the cash book and directly from journal entries for all other accounting transactions.
Liabilities
Money you owe to others. This can be current (payable within one year) or long-term. Long term liabilities, along with Share Capital and Reserves make up one side of the balance sheet equation showing where the money came from. The other side of the balance sheet will show Current Liabilities along with various Assets, showing where the money is now.
LIBID
The London Interbank Bid Rate (LIBID) is a bid rate; the rate bid by banks on Eurocurrency deposits (i.e. the rate at which a bank is willing to borrow from other banks). It is "the opposite" of the LIBOR (an offered, hence "ask" rate). Whilst the British Bankers' Association BBA LIBOR rates, there is no correspondent official LIBID fixing.
LIBOR
London Interbank Offered Rate (or LIBOR, pronounced LIE-bore) is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market (or interbank market). LIBOR will be slightly higher than the London Interbank Bid Rate (LIBID), the rate at which banks are prepared to accept deposits.
LIFO
A method by which the goods sold are said to have come from the last lot of goods received.
Limited Company
A limited company is where the owners of the business are the shareholders but the business may be managed by a completely different set of people, the directors.
In legal terms, a limited company is a completely separate entity from the owners, the shareholders. Many companies are run as private limited companies (Ltd), and often, the shareholders and the directors, are the same people.
The largest companies however, are public limited companies (PLC). In these companies, the shareholders and the directors are completely different. The directors run the company on behalf of the shareholders, the owners, and are accountable to the shareholders for their management of the business and stewardship of the assets.
The shareholders provide capital for the business by buying shares in the company and they share in the profits of the company by being paid dividends.
The accounting records that are required for a limited company are regulated by law See Sole Trader and Partnership for a comparison of different business types.
Limited Liability
The main difference between the trading of a sole trader or partnership and a limited company is the concept of limited liability.
If the business of a sole trader or a partnership is declared bankrupt then the owner or owners are personally liable for any outstanding debts of the business.
However, the shareholders of a company have limited liability. This means that once they have fully paid for their shares they cannot be called upon for any more money if the company is declared bankrupt. All they will lose is the amount they paid for their shares.
Limited Liability Partnerships (LLP)
With this form of partnership, there is limited personal liability for individual partners (similar in manner to a limited company). For tax purposes, an LLP does not differ greatly from an ordinary partnership.
Limited Partner
A partner whose liability is limited to the capital he or she has put into the firm.
Limiting Factor
Anything that limits activity. Typically, this would be the shortage of supply of something required in production, for example, machine hours, labour hours, raw materials, etc. However, it could also be something that prevents production occurring, for example a lack of storage for finished goods, or a lack of a market for the products.
Liquidation
When a business or firm is terminated or bankrupt, its assets are sold and the proceeds pay creditors. Any leftovers are distributed to shareholders. This process is liquidation.
Liquidity
This is the measure of how much cash you have and is it enough for your needs. It can include things that can be turned into cash quite quickly like debtors and other current assets. A ‘liquidity problem’ is where you don’t have enough cash to pay your immediate bills.
Liquidty Ratios
Those ratios that relate to the cash position in an organisation and hence its ability to pay liabilities when due.
Loan
An arrangement in which a lender loans money or property (known as the principal or principle amount) to a borrower and the borrower agrees to return the principal amount or repay the money, usually along with interest, at some future point(s) in time. Usually, there is a predetermined time for repaying a loan.
Long-term asset
Long-term assets are those assets usually in service over one year such as buildings, equipment, etc. These often receive favourable tax treatment over short-term assets.
Long-Term Liabilities
Liabilities that do not have to be paid within twelve months of the Balance Sheet date.
Loss
The result of selling goods for less than they cost to purchase.
Main Ledger
This is where the double-entry takes places of all transactions of the business.
Management Accounting
Management accounting is concerned with the provision and use of accounting information to enable managers of a business in their decision making and management control functions.
The main features of management accounting are that it:
- Uses accounting information to summarise transactions that have happened already and to make estimates for the future • Looks in detail at the costs - materials, labour and expenses, and the sales income of products and services
- Looks forward to predict what is likely to happen in the future
- May use estimates where these are the most useful or suitable form of information
- Provides management with reports that are of use in running the business or organisation
- Provides management information as frequently as circumstances demand - speed is often vital as information may go out-of-date very quickly
- Is not sent to people outside the organisation - it is for internal use
- Maintains confidentiality of information (e.g. payroll details)
Margin
The purchase and sale of a good may be shown as Cost Price + Profit = Selling Price. The profit when expressed as a fraction, or percentage, of the selling price is known as the margin. Margin Of Safety The gap between the level of activity at the break-even point and the actual level of activity.
Marginal Cost
Marginal cost is the cost of doing one more thing, e.g. making the 101st widget, when all the set up costs have already been included in the costs of producing the 1st 100 widgets. Producing 100 widgets costs £200, including all the set up costs of £150 (i.e. £2 per widget) and producing the 101st widget will cost £200.50 in total. As the first 100 widgets are already produced and the set up costs have already been covered, the marginal cost of producing the 101st widget will be £200.50 - £200 = £0.50 – different from the Average Costs example earlier in the Glossary.
Marginal Costing
An approach to costing that takes account of the variable cost of products rather than the full production cost. It is particularly useful when considering utilisation of spare capacity.
Mark-up
The purchase and sale of a good may be shown as Cost Price + Profit = Selling Price. The percentage added to the cost price to provide a profit is known as the mark-up.
Materiality
The concept that something should only be included in the financial statements if it would be of interest to the stakeholders, i.e. to those people who make use of financial accounting statements. It need not be material to every stakeholder, but it must be material to a stakeholder before it merits inclusion. In effect it means 'big enough to bother about'. For example a £100 error in the petty cash may be very 'material' to a small business but 'immaterial' for a big national company. The basic test of materiality is - if the reader of the accounts would form a different opinion if they knew about it, then it is material.
Measurement Basis
The monetary aspects of the items in the financial statements, such as the basis of the stock valuation, say FIFO or LIFO.
Mediation
Mediation is a well-established process for resolving disagreements in which an impartial third party (the mediator) helps people in dispute to find a mutually acceptable resolution.
Mortgage
A repayable loan secured on property. The borrower (called the mortgagor) offers up property to the lender (called the mortgagee) as security for a debt.
Narrative
A description and explanation of transactions recorded in the journal.
Negative Contribution
The excess of direct costs allocated to a section of a business over the revenue from that section.
Negative Goodwill
The name given to the amount by which the total purchase price for a business a limited company has taken over is less than the valuation of the assets at that time. The amount is entered at the top of the fixed assets in the balance sheet as a negative amount. Sole traders and partnerships can use this approach instead of a capital reserve.
Net
The amount that remains after all deductions have been made.
Net Book Value (NBV)
The net value of an asset. Equal to its original cost (its book value) minus depreciation and amortisation. Also called net book value and depreciated cost.
Net Current Assets
Current assets minus current liabilities. The figure represents the amount of resources the business has in a form that is readily convertible into cash. Same as working capital.
Net income
Refers to the profits of a company after expenses and is calculated as gross profit less operating expenditure.
Net Loss
Where the cost of goods sold plus expenses is greater than the revenue.
Net Present Value (NPV)
The sum of the present values of a series of cash flows.
Net Profit
This is the amount earned by a company after expenses. This is calculated as; Gross Profit - Expenses = Net Profit.
Net Realisable Value
The amount that would be received for the immediate sale of stock, after accounting for any costs associated directly with the sale.
Net Worth
The value of a business as represented by subtracting its liabilities from its assets; Assets - Liabilities = Net Worth. Nominal Account Accounts in which expences, revenue and capital are recorded.
Nominal Ledger
Another name for the General Ledger. This ledger is the core of the accounting process. It is affected by all transactions posted in all ledgers. The balances on all of the nominal accounts form the Trial Balance and therefore the Profit and Loss and the Balance Sheet.
Normal Losses
Losses arising in the production process that could not be avoided.
Opening Balance
The balance of an account when it is initially opened, or the balance carried over from the previous accounting period, (i.e. last accounting periods’ closing balance.)
Operating Lease
An agreement whereby the leaser retains the risks and rewards associated with ownership and normally assumes responsibility for repairs, maintenance and insurance.
Operating Profit
This is calculated; Gross Profit - Expenses.
It is the same as net profit unless the business has other income from investments or expenditure on loan interest. These items are not considered in calculating the Operating Profit.
Opportunity Costs
These are costs associated with losing the opportunity to do something else with your time.
Ordinary Shares
Shares entitled to dividends after the preference shareholders have been paid their dividends. Output Tax VAT added to the net price of outputs (i.e. sales). Outputs Sales of goods and services.
Overdraft
A facility granted by a bank that allows a customer holding a current account to spend more than the funds in the account. Interest is charged daily on the amount of the overdraft on that date and the overdraft is repayable at any time upon demand from the bank.
Overheads
Sometimes called core costs, these are the costs which must be paid for by all the projects and activities of the organisation, e.g. accounting fees, some salaries, office rent, etc.
Owners’ equity
Owners’ equity, also known as risk or liable capital, is a financial term for the difference between a company's assets and liabilities -- that is, the value that accrues to the owners (sole proprieter, partners, or shareholders). In a corporation, it is called shareholders' equity. In bankruptcy, ownership equity is the last or residual claim against assets, paid only after all other creditors are paid.
Paid-Up Share Capital
The amount that shareholders of a company have paid to the company for their fully-paid shares.
Parent Undertaking
An undertaking which controls or has a dominating influence over the affairs of another undertaking.
The terms 'parent undertaking' and 'subsidiary undertaking' have been in use for only a few years. Previously, a parent undertaking was called a 'holding company', and a subsidiary undertaking was called a 'subsidiary company'.
One of the reasons these terms have been changed was that consolidated financial statements used to be concerned only with companies. Now, subsidiary undertakings can include unincorporated businesses as well.
Pareto Principle
Also known as the 80/20 Rule, states that, for many events, 80% of the effects come from 20% of the causes.
It is a common rule of thumb in business; e.g., "80% of your sales comes from 20% of your clients."
Partnership
A partnership is a group of individuals who are trading together with the intention of making a profit. Partnerships are often created when a sole trader's business expands and more capital and more expertise is needed.
Typical partnerships are those of accountants, solicitors and dentists and usually comprise between 2 and 20 partners. A partnership will tend to be larger than sole traders; there will tend to be more employees and a greater likelihood of a bookkeeper being employed to maintain the accounting records.
Each of the partners will contribute capital to the business and will normally take part in the business activities. The profits of the business will be shared between the partners; setting up a partnership agreement whereby the financial rights of each partner are set out normally does this. Just as with sole traders the partners will tend to withdraw the profits due to them from the business in the form of drawings, although in some cases partners may also be paid a salary by the business.
Partnership Return (form SA800)
This shows each partner’s share of profits (or losses) and must be filed with HMRC annually.
PAYE (Pay As You Earn)
The system whereby income tax is deducted from wages and salaries by employers and sent to HM Revenue & Customs.
Payee
The person / company to who a cheque is being paid.
Payroll
The process of paying employees by calculating the gross remuneration due less statutory deductions for tax and National Insurance (NI) and other deductions.
P/E ratio (price per earnings)
The P/E ratio is an important indicator showing how the investing market views the health, performance, prospects and investment risk of a public company listed on a stock exchange (a listed company). The P/E ratio is also a highly complex concept - it's a guide to use alongside other indicators, not an absolute measure to rely on by itself.
The P/E ratio is arrived at by dividing the stock or share price by the earnings per share (profit after tax and interest divided by the number of ordinary shares in issue). As earnings per share are a yearly total, the P/E ratio is also an expression of how many years it will take for earnings to cover the stock price investment.
P/E ratios are best viewed over time so that they can be seen as a trend. A steadily increasing P/E ratio is seen by the investors as increasingly speculative (high risk) because it takes longer for earnings to cover the stock price. Obviously whenever the stock price changes, so does the P/E ratio. More meaningful P/E analysis is conducted by looking at earnings over a period of several years. P/E ratios should also be compared over time, with other company's P/E ratios in the same market sector, and with the market as a whole.
Step by step, to calculate the P/E ratio:
1. Establish total profit after tax and interest for the past year.
2. Divide this by the number of shares issued.
3. This gives you the earnings per share.
4. Divide the price of the stock or share by the earnings per share.
5. This gives the Price/Earnings or P/E ratio.
Personal Allowances
Amounts that may subtract from income in order to arrive at taxable income. The value of each allowance is set by the government following the Budget each year.
Petty cash
Businesses often need small amounts of cash, known as petty cash, for expenditures where it is not practical to make the payment by other means.
Petty Cash Book
A Cash Book to record petty cash payments.
Posting
The process of entering a transaction on your accounts record.
Preference Shares
Shares that are entitled to an agreed rate of dividend before the ordinary shareholders receive anything.
Preliminary Expenses
All the costs that are incurred when a company is formed.
Prepayments
A payment for goods or services before they are received. e.g. Insurance paid 1 year in advance and accounted for over 12 months.
A prepayment is an asset because is something that has been paid for but not yet used.
Present Value
The amount that a future cash flow is worth in terms of today's money.
Prime Cost
Direct materials plus direct labour plus direct expenses.
Principal
The loan amount, or the part of the loan amount that remains unpaid (excluding interest). Also called principal amount.
Private Ledger
A ledger for capital and drawings accounts.
Process Costing
A costing system that is applied when goods or services are produced in a continuous flow.
Production Cost
Prime cost plus indirect manufacturing costs.
Profit
The excess of revenues over costs in a business.
Profit and Loss Report
A report that categorises the income and expenditure of a business over an accounting period. The profit (or loss) of a business is its income less its expenditure; profit is analysed, along with gross profit (sales less the cost of those sales) and net profit (all income less all expenditure, before and after tax has been deducted).
Provision
An amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with 'substantial accuracy'.
Provision for Bad Debt
An amount put by for those debts which may not be paid. It appears as an expense on the profit and loss account and is deducted from the debtors control account.
Prudence
Ensuring that profit is not shown as being too high, or that assets are not shown at too high a value and that the financial statements are neutral: that is, that neither gains nor losses are understated or overstated.
Public company
A company that can issue its shares publicly, and for which there is no maximum number of shareholders.
Purchases
Goods or services bought for the purpose of making a direct sale. e.g. Material costs such as stationary that is resold, hardware that is resold etc.
Purchase Credit Notes
These are issued by suppliers in order to cancel purchase invoices either in full or in part. They are normally issued when goods or services are faulty or when the purchase invoice was incorrect.
Purchase Discounts
Purchase Discounts may be given for a variety of reasons, e.g. buying in bulk, spending large amounts, being a preferred customer or settlement discount.
Purchase Invoices
These are issued by suppliers as a request for payment in respect of the supply of goods or services.
Purchase Ledger
The purchase ledger keeps track, in account order, of all invoices, credit notes and discounts received from suppliers and all payments to suppliers. It can be quickly referred to if you want to find the current status of any of the supplier accounts. The total balance outstanding should equal the balance of the creditors control account in the nominal ledger.
Purchase Payments
Payments made to suppliers in respect of invoices for the goods and/or services supplied.
Purchases Day Book
Book of original entry for credit purchases. Also called the Purchases Journal.
Quick Ratio
A ratio for calculating the liquidity of a business. It is calculated as : - (Current Assets - Stock) ÷ Current Liabilities
This ratio is used to see the solvency of a company. It is also referred to as the "liquid ratio" or "acid-test ratio".
A written acknowledgment that a specified article, sum of money, or shipment of merchandise has been received.
Receipts
Unless otherwise qualified, in accounting means cash received.
Receivable
An amount awaiting receipt of payment.
Reconciliation
The process of agreeing accounting entries from one source, with entries from another source. The most common reconciliation is a bank reconciliation, which matches transactions posted against a bank account with the statement received from the bank.
Reduced Rate (of VAT)
A lower VAT rate applicable to certain goods and services.
Reducing Balance Method
A method of calculating depreciation based on the principle that you calculate annual depreciation as a percentage of the net-of-depreciation-to-date balance brought forward at the start of the period on the fixed asset.
Registered Business
A business that has registered for VAT. It must account for VAT and submit a VAT Return at the end of every VAT tax period.
Remittance Advice
A document accompanying a receipt, showing which invoices less credit notes are being paid.
Remittance List
A listing of all the receipts of the business for a period, usually that day.
Reserve Accounts
The transfer of apportioned profits to accounts for use in future years.
Reserves
The accumulated and retained difference between profits and losses year on year since the company's formation.
Residual Value
The net amount receivable when a fixed asset is put out of use by the business.
Retained earning
Retained earnings are profits that were not paid to a company's shareholders. They are reported in the ownership equity section of the firm's balance sheet. Dividing profits between dividends and retained earnings depends on at least two things: the firm's judgement of its own investment opportunities relative to those available in the market and any difference in tax treatment of dividends paid now and capital gains expected to result from investing retained earnings.
Retention
An amount of money retained by a customer for a specified period of time after a service has been provided, to ensure that if anything should subsequently go wrong then it will be rectified.
Return on Capital Employed (R.O.C.E.)
Return on Capital Employed = (Net Profit ÷ Capital Employed) x 100
This is one of the most important profitability ratios, as it encompasses all the other ratios, and because an adequate return on capital employed, is why people invest their money in a business in the first place.
This ratio gives an indication as to how much profit in percentage terms is being earned from the money invested in the business. If the owner could earn more from investing the capital in a building society, it would be pointless running the business.
There are several ways of calculating this ratio in respect to the capital employed figure. Sometimes it is Opening Capital, sometimes the Closing Capital and sometimes the Average Capital.
Return on investment
A fundamental financial and business performance measure. This term can mean different things to different people (often depending on perspective and what is actually being judged) so it's important to clarify understanding if interpretation has serious implications.
Many business managers and owners use the term in a general sense as a means of assessing the merit of an investment or business decision. 'Return' generally means profit before tax, but clarify this with the person using the term - profit depends on various circumstances, such as the accounting conventions used in the business. In this sense most CEO's and business owners regard ROI as the ultimate measure of any business or any business proposition, after all it's what most business is aimed at producing - maximum return on investment, otherwise you might as well put your money in a bank savings account.
Strictly speaking Return On Investment is defined as:
Profits derived as a proportion of and directly attributable to cost or 'book value' of an asset, liability or activity, net of depreciation.
In simple terms this is the profit made from an investment. The 'investment' could be the value of a whole business (in which case the value is generally regarded as the company's total assets minus intangible assets, such as goodwill, trademarks, etc and liabilities, such as debt.
Return On Owners' Equity
Net profit as a percentage of ordinary share capital plus all reserves, often abbreviated as ROOE. The more common term in use for this is (return on shareholders' funds).
Return On Shareholders' Funds
Net profit as a percentage of ordinary share capital plus all reserves, often abbreviated as ROSF and more commonly used than the alternative term, return on owners' equity.
Returns
Goods returned to the business by a customer, or by the business to a supplier.
Revaluation Account
An account used to record gains and losses when assets are revalued.
Revenue
Another term for sales or income.
Revenue Expenditure
Expenses needed for the day-to-day running of the business.
Revenue Reserves
A balance of profits retained available to pay cash dividends including an amount voluntarily transferred from the profit and loss appropriation account by debiting it, reducing the amount of profits left for cash dividend purposes, and crediting a named reserve account, such as a general reserve.
Rights Issue
A rights issue is a way in which a company can sell new shares in order to raise capital. Shares are offered to existing shareholders in proportion to their current shareholding, respecting their pre-emption rights. The price at which the shares are offered is usually at a discount to the current share price, which gives investors an incentive to buy the new shares - if they do not, the value of their holding is diluted.
Partnership Return form This shows each partner’s share of profits (or losses) and must be filed with HMRC annually.
Sale or Return
Goods supplied on the understanding that if not sold on (by the customer/retailer) they may be returned without charge. Such transactions are best not recorded in the accounts, until the actual sales figures are known. Examples include newspapers and magazines.
Sales
Goods sold by the business in which it normally deals, which were bought with the prime intention of resale.
Sales Credit Notes
These are issued to customers in order to cancel sales invoices either in full or in part. They are normally issued when goods or services are faulty or when the sales invoice was incorrect.
Sales Day Book
Primary record for recording sales invoices, ie credit sales.
Sales Discounts
Sales Discounts may be allowed for a variety of reasons, e.g. buying in bulk, spending large amounts, being a preferred customer (trade discount) or settlement discount.
Sales Invoice
A document showing details of goods sold and the prices of those goods.
Sales Ledger
The sales ledger keeps track, in account order, of all invoices, credit notes and discounts sent to customers and all receipts received from customers. It can be quickly referred to if you want to find the current status of any of the customer accounts. The total balance outstanding should equal the balance of the debtors control account in the nominal ledger.
Sales Receipts
These are made when invoices are paid off by the recipient of the goods or services.
Sensitivity Analysis
Also called 'what if' analysis. Altering volumes and amounts so as to see what would be likely to happen if they were changed. For example, a company may wish to know the financial effects of cutting its selling price by £1 a unit.
Settlement Discount
A Settlement or cash Discount is a percentage discount of the total invoice value that is offered to a customer to encourage early payement. For example, if it is normal policy to request that payment is made by customers 30 days after the invoice date, a cash discount of 4% might be offered for payment within 10 days of the invoice date.
A cash discount differs from a trade discount in that although the seller offers the discount to the customer it is up to the customer to decide whether or not to accept the offer of the discount. Therefore the discount does not appear on the face of the invoice but it will be noted at the bottom of the invoice in the "Terms" section.
There is one complication here with VAT. If a cash discount is offered then the VAT is calculated on the assumption that the cash discount is taken up by the customer and therefore the VAT calculation is made based upon the net invoice total after deducting the cash discount.
Shares
The division of the capital of a limited company into parts or shares.
Documents issued by a company to its owners (the shareholders) which state how many shares in the company each shareholder has bought and what percentage of the company the shareholder owns. Shares can also be called 'Stock'.
Share capital
The balance sheet nominal value paid into the company by shareholders at the time(s) shares were issued
Share Discount
Where a share was issued at a price below its par, or nominal value, the shortfall was known as a discount. However, it is no longer legal under the Companies Acts to issue shares at a discount.
Share Premium
Where a share is issued at a price above its par, or nominal value, the excess is known as a premium.
Shareholder
A shareholder is an individual or company (including a corporation), that legally owns one or more shares in a company. Companies listed at the stock market strive to enhance shareholder value.
Shareholders are granted privileges depending on the class of share, including the right to vote (usually one vote per share owned) on matters such as elections to the board of directors, the right to share in distributions of the company's income, the right to purchase new shares issued by the company, and the right to a company's assets during a liquidation of the company.
Shareholders' equity
In business and accounting, shareholder equity is everything of the company that is owned by the shareholders.
Shareholders' funds
A measure of the shareholders' total interest in the company represented by the total share capital plus reserves.
Shares At No Par Value
Shares that do not have a fixed par, or nominal value.
Simple Interest
Simple Interest (I) is calculated by multiplying the amount invested (sometimes called the principle, P) by the length of time (T) the money is invested and the rate of interest (R) converted to a equation; that is: I = ( P x R x T ) / 100.
Sinking Fund
An account set up to reduce another account to zero over time (using the principles of amortisation or straight line depreciation ). Once the sinking fund reaches the same value as the other account, both can be removed from the balance sheet.
SME
Small and Medium Enterprises (ie. small and medium size businesses). The distinction between what is 'small' and what is 'medium' varies depending on where you are and who you talk to.
Sole Trader
The simplest type of business is that of a sole trader. A sole trader is someone who trades under his or her own name.
Many, many businesses are sole traders, from electricians through to accountants. Being a sole trader does not mean that the owner is the only one working in the business. Some sole traders are one-man businesses, but many will also employ a number of other staff.
The owner of the business will have contributed capital to finance the business, although it may also have loans, either commercial or from friends. The owner is also the only party to benefit from the profits of the business. When the owner takes money, or goods out of the business it is referred to as drawings.
Source of Funds / Capital Employed
Any money invested into the business including Share Capital, Reserves, and long-term loans.
Standard Cost
What you would expect something to cost.
Standard Costing
A control technique that compares standard costs and standard revenues with actual costs and actual revenues in order to determine differences (variances) that may then be investigated.
Standard Rate
The VAT rate usually used.
Standard Rated Business
A business that charges VAT at the standard rate on its sales.
Standing Order
An order made by a customer (business or personal) to their bank to pay a specified amount usually on or around a particular day of the month regularly to another account.
Statement
A copy of a customer's account taken from the supplier's books showing unpaid invoices and unallocated credit notes. A statement may include an aged analysis to show amounts outstanding over 30 days, 60 days, 90 days, and more.
Statement Of Affairs
A statement from which the capital of the owner can be found by estimating assets and liabilities. Then Capital = Assets - Liabilities. It is the equivalent of the balance sheet.
Stock
The total goods or raw materials held by a business for the purpose of resale. Stock is valued in the balance sheet at the lower of cost and net realisable value. (Also known as inventory.)
Stock Explosion
A report to show what components each stock item is made up of. For example, a stereo system could be made up of a set of speakers, an amplifier, a CD player, a tape-deck and some connecting wires.
Stock Turnover
The number of times stock is sold in an accounting period. (Also known as 'stockturn'.)
Stocktaking
The process of physically identifying and counting the stock on hand at a given point in time.
Straight Line Method (Depreciation)
See Depreciation - Straight Line Depreciation Method.
Subsidiary Company
The outdated term for what is now known as a 'subsidiary undertaking'.
Subsidiary Undertaking
An undertaking which is controlled by another undertaking or where that other undertaking exercises a dominating influence over it.
Subsidiary Ledgers
These are ledgers where supporting or memorandum ledger accounts are kept, in addition to the main ledger.
Sunk cost
Sunk costs are costs that have already been incurred and which cannot be recovered to any significant degree. Sunk costs should not influence decisions because they have already been incurred and cannot affect a decision.
Suspense Account
A temporary account that is used when you are unsure as to what you should do with a certain value. The Suspense Account can be used as a holding account until it is decided what should be done with the value. The balance on the Suspense Account should ultimately be zero.
The layout of accounts in the accounting books. The T-account is the basis for journal entry in accounting. T-accounts have three basic elements. A title, a left side (debit side) and a right side (credit side). To make an entry in a T-account, put the currency (dollar, pound, etc.) amount on the appropriate side (debit or credit).
Tangible Asset
Assets having a physical existence, such as cash, equipment,, stock and property. Accounts receivable are also usually considered tangible assets for accounting purposes.
Tax Code
The number found by adding up an individual's personal allowances which is used to calculate that individual's tax liability.
Total Cost
Production cost plus administration, selling and distribution expenses and finance expenses.
Trade Discount
A reduction from the sales list price that a business might offer to some of its customers. The amount of the trade discount will be shown on the face of the invoice as a deduction from the list price. A Settlement Discount is different.
Trading Account
Compares sales, stock used and direct expenses to find the profit or loss made by buying and selling.
Trading And Profit And Loss Account
A financial statement in which both gross profit and net profit are calculated.
Transposition Error
Where the characters within a number are entered in the wrong sequence.
Trial Balance
A list of all the nominal accounts at a given time, together with their net balances, shown as either a debit or a credit balance.
The double entry book-keeping system, if completed correctly, requires that the total of all debits equals the total of all credits. In theory the balances should always be equal when using computer accounts programs. If an imbalance occurs, it may indicate that you have corrupt data.
Tronc
A monetary pool in which tips / gratuities are collected and later shared out between all staff, e.g. in a restaurant.
The person who shares out the tips is called a 'troncmaster'.
'tronc', from the French 'tronc des pauvres', poor box
True And Fair View
The expression that is used by auditors to indicate whether, in their opinion, the financial statements fairly represent the state of affairs and financial performance of a company.
Cheques paid out which are passing through the bank clearing system, but have not yet been presented to the bank where the account is maintained.
Unregistered Business
A business that is not VAT registered. It ignores VAT and treats it as part of the cost of purchases. It does not charge VAT on its outputs. It does not need to maintain any record of VAT paid.
Valuation
Formal assessment of the worth of property, goods etc.
Value Added Tax (VAT)
A tax charged on the supply of most goods and services.
- VAT is applied to all VAT registered businesses for a Net Sale or Purchase amount.
- VAT is a tax imposed by the government on certain goods/services supplied. For current information about VAT rates etc, see HM Revenue & Customs website.
- When a business is registered for VAT it is able to claim back VAT paid on goods/services.
Variable Costs
Expenses which change in response to changes in the level of activity.
Variance
The difference between budget and actual. Can also be used to describe the difference between the opening and closing balance of an account.
Variance Analysis
A means of assessing the difference between a predetermined cost/income and the actual cost/income.
VAT Cash Accounting
A special arrangement for accounting for VAT that must be agreed with HM Revenue & Customs. VAT is charged on amounts actually received net of amounts paid, rather than on the invoices for those amounts.
VAT Invoice
An invoice issued by a supplier registered for VAT showing the supplier’s VAT registration number, the date of issue and the tax point.
VAT Outputs and Inputs
VAT charged on sales is referred to as Outputs and VAT incurred on purchases is referred to as Inputs.
VAT Receipt
A receipt showing the amount of VAT as a separate item, together with the supplier’s VAT registration number.
VAT Registration
All businesses registered for VAT are given a registration number. This number must be printed on all invoices.
VAT Return
All businesses registered for VAT are required to submit a statement each quarter to HM Revenue & Customs to account for VAT Outputs and Inputs. The VAT Return is a declaration which determines the liability to pay VAT, or receive a refund.
VAT Tax Point
The date on which VAT eligible sales are completed.
'What If'
Also called sensitivity analysis. The process of altering volumes and amounts so as to see what would be likely to happen if they were changed. For example, a company may wish to know the financial effects of cutting its selling price by £1 a unit.
Work In Progress (W.I.P)
Items not completed at the end of an accounting period.
Working Capital
The excess of current assets less current liabilities. The figure represents the amount of resources the business has in a form that is readily convertible into cash. Same as net current assets.
Write Off
In accounting, writing off is the expensing of a balance sheet asset that has no future benefits.
An example would be the writing off of goodwill. The worthless asset will be recorded as an expense on the current period's income statement rather than keeping it on the balance sheet as an asset.
Similar to a write off is a write down. This is a partial write off. Only part of the value of the asset is removed from the balance sheet.
Writing off can be used to:
- cancel a bad debt or obsolete asset from the accounts.
- consider a transaction as a loss or set off (a loss) against revenues.
- depreciate an asset by periodic charges.
- charge a specified amount against gross profits as depreciation of an asset.
Yield
The annual income provided by an investment.
Zero-Rated
Denoting goods on which the buyer pays no VAT although the seller can claim back any tax he/she has paid.
These include some food items, newspapers, magazines and books, medicine and children’s clothing.
Zero-Rated Business
A business that only supplies zero-rated goods and services. It does not charge VAT to its customers but it receives a refund of VAT on goods and services it purchases.