Accountants, lawyers, doctors and other professionals spend years training to be able to do their jobs. That time teaches them all sorts of complex things and also, inexplicably, seems to result in all of them having terrible handwriting.
A side effect of spending so much time studying and working with topics and concepts that most people don’t come across on a daily basis, is that these professionals become de-sensitised to the fact that what they know is not common knowledge. Consequently they will happily throw around terms which are completely incomprehensible to anyone outside of their profession.
That’s one possible explanation, the other is that we all deliberately use words that we know other people don’t understand in order to make ourselves seem more intelligent. I prefer to believe the first one!
So, I thought it might be useful to set out some of the common terms and what they really mean. These are not technical definitions, these are more approachable explanations of technical terms:
Accounts - this has two meanings, each account is a category within the numbers to show that those figures relate to something, bank, cash, assets, cost of sales etc. The other meaning is an informal name for what are more correctly called the financial statements.
Accrual - including costs in the accounts before the cash is paid.
Amortisation - similar to depreciation (see below). This is how we spread the cost of intangible, or non-physical, assets over their life. For example, if we believe that a trade mark has a useful life of ten years, then each year amortisation of one tenth of the cost will be put through the accounts.
Assets - things you own which you can make money from in future or you could sell, or they are just money!
Audit - a formal process, during which a suitably qualified and registered person reviews the financial statements and says whether or not they are “materially” correct and give a “true and fair view”
Balance sheet - a snapshot taking the overall financial position of the company at a point in time.
Cashflow - the movement of cash and also one of the main statements in the financial statements. A cash flow statement shows how the movement in profit relates to the movement in cash.
Chart of Accounts - a listing of all of the available accounts for use within a company. Very important in the digital age as there are often rules around creating new accounts in the chart of accounts, so the available list might be all that is on offer.
Contingency – the excess or buffer, it is typical in large contracts or projects to have a contingency based on the overall value, e.g. 10% of other costs.
Contingent assets or liabilities - items which may become assets or liabilities in future, depending on the outcome of an unknown situation. They are not included in the figures for the business but if they meet certain criteria then they need to be declared.
Cost centres – a way of dividing up the costs of the business to match with areas of responsibility. Small companies within the company where costs can be captured and managed as a smaller part of the whole cost.
Cost of sales - the cost of an item and any associated costs that are necessary in order for it to be available for sale.
Covenant - a rule set out by a lender which must be adhered to at all times. Typically they relate to cash or the ability to pay (or “service” the debt). When a covenant is breached it could potentially cause the lender to withdraw the facility.
Currency Hedging - a solution to protect a business from adverse currency fluctuations
Current - within the next twelve months, usually.
Debits and credits - in simple terms this is the accounting equivalent of positive and negative.
Depreciation - the method of allocating the cost of an asset over its Useful Economic Life. It can be calculated in a few ways but the basic process takes the cost of the asset, less the amount you expect to be able to sell it for when it is no longer useful to you (the residual value) and spreads that over the period of time that you expect to use it (the Useful Economic Life).
Discounting - not the black friday version of giving a discount on a price, but the process of taking into account that money now is worth more than money later. The rate at which that happens is the discount factor, expressed as a percentage.
Double entry accounting - the beautiful basis of the whole accounting structure. For every entry, there is an equal and opposite entry, or a group of other entries that are equal and opposite. That means that for every plus we have a minus, so when we spend cash, we gain an asset. Similarly if we dispose of an asset we gain cash.
Earnings - the same as profit.
EBIT - earnings before interest and tax. This is used when you want to ignore the impact of borrowing levels and government taxation policy on the performance of a business. It should help to make different businesses more comparable from an investment perspective, particularly if you are planning on lending them the money they need and being on the receiving end of the interest.
EBITDA - this is a favourite of the private equity world as it generally makes business performance more comparable. Technically it is Earnings (profit) Before Interest, Tax Depreciation and Amortisation - in real terms that means that it is profit ignoring how much money you owe, how much tax you had to pay and the accounting impact of long term assets. This is an extension of EBIT as it also removes the depreciation impact, so it takes out the accounting adjustment of depreciation and looks at the true underlying performance of the trading business.
Financial statements - the formal format for showing the financial performance of a company, the Financial statements include a balance sheet, a profit and loss or income statement, sometimes a cash flow and then the notes explaining the decisions and details behind the numbers. There will also be a directors statement and sometimes an audit report.
Fixed assets - the things that the business owns which will be used for more than a year to generate profit - the factory, the cars, the website, among others.
Goodwill - essentially this is the inherent value of something over and above the physical value. If you buy a business, the value is almost certainly not going to be equal to the value of the assets, as the brands and customer lists etc have a value that is not recorded in the accounts. The difference between what it is worth and what you can put a value on, is the goodwill. This has become much more tricky in recent times as we are now expected to put a value on brands and customer lists as intangible assets! That still leaves a gap though - the x-factor in company valuation.
Input and output VAT - input VAT is on the stuff you bought, output is on the stuff you sold
Inventory - the same as stock, items you have purchased or made that you intend to sell or that you will use to make something you will sell.
Ledger - accountant speak for a list of transactions. Our favourite is the excitingly named “General Ledger”, it is a full listing of everything that affects the numbers. There are sub ledgers, which hold the details relating to certain aspects, sales and purchases for example, but the general ledger is everything when it comes to the overall figures.
Liabilities - obligations to pay out money in the future.
Line of credit - an agreement with a bank or other lender to make funds available if required, these usually come with conditions and covenants.
Margin - the difference between sales price and cost
Margin percentage - the margin divided by the sales price
Markup - the margin divided by the cost - 100% markup is only 50% margin, don’t get them confused! For example, if I buy something for £1 and sell it for £2, my markup is 100% (I have added the full cost on as profit) and my margin is 50% (my profit is 50% of the sales price.)
Materiality - principally an audit term again, something is material if it is big enough to be a concern. Something could be material due to its nature and not its size, for example, fraud.
Practice v industry - practice relates to accountants working at a firm of accountants, doing tax, audit, financial statements etc, industry is our word for accountants who work in other businesses.
Prepayment - taking a cash payment and moving the accounting impact into later periods, so that the expense matches with the timing of the benefit. For example, if you pay for a year of rent in advance on the last day of your accounting year, there shouldn’t be any cost in the current year, so it is prepaid into the next year to match with the period when you get to use the asset.
Profit and loss account (P&L) - a breakdown of the profit earned in the period, profit might be negative!
Provision - similar to an accrual, it must relate to something that has already happened, but in this instance we don’t yet know what the outcome is going to be. To have a provision you have to have a probable future outflow of cash relating to a past event.
Reserve - money put to one side for a particular reason, this can prevent the use of these funds for other reasons.
Shareholders - people or companies that own the shares of the business, the investors/owners.
Stakeholders - anyone or any organisation that has an interest in the business and its performance and activities. The employees, government, local residents, banks can all be considered stakeholders.
Tangible and intangible - categories of assets, the first are ones you can touch, the second are not - brands, trademarks etc.
Trial Balance - this is a list of all of the accounts of the business and their balances. It’s called a trial balance as it has a list of debits and credits, or positives and negatives, that should always add up to nil - the trial balance used to be drawn up in order to make sure that the figures balanced. In the days of computer systems and rules preventing entries that don’t balance, the “trial” element is less important, but the trial balance remains a very useful report for accountants.
True and fair view - this term relates to audit, but can be used in other forms of assurance, it means that the information is accurate enough that it won’t mislead the users of the information.
Shareholders funds - how much value do the shareholders have on paper.
Useful Economic Life - the period over which you expect an asset to have a value to the business.
Weighted average cost of capital (WACC) - The cost of capital of a business is the amount that it costs them to have cash. Interest paid on borrowings is a part of it, as is the expected return of the shareholders. When you have multiple sources of capital, you need to take all of them along with their relative weighting based on the amount of each you have, or intend to have, and work out the weighted average. This is then used to understand the cost of having excess cash in the business, or additional investment and so makes the perfect starting point for a discount factor.
Working capital - this is the stuff you have which is used in everyday trading and is either tying up cash or is going to use cash soon - stock, trade debtors and trade creditors, basically. This is very useful in working out if a company’s cash position is higher or lower than it really should be.
Got any others? Send them to me and I will add them to the jargon buster!