This is simply the period of time covered by an income statement. A balance sheet is created on the last day of an accounting period to reflect the business’ financial position at that time.
Also referred to as trade creditors. These are amounts due by the business to others such as suppliers of inventory and other services. As these accounts payable fall within the current liabilities section of the balance sheet they are, by definition, due to be paid within 12 months from the date of the balance sheet but, in reality, are usually payable within a much shorter time period, probably within a maximum of 30 days.
Also referred to as trade debtors. These are amounts due to the business by others, usually its customers. As these accounts receivable fall within the current assets section of the balance sheet they are, by definition, due to be paid within 12 months from the date of the balance sheet but, in reality, are usually receivable within a much shorter time period which will be defined by the credit terms that the business allows its customers.
Also referred to as “accruals”. This is the result of the accounting system known as “accrual accounting” which is widely used (and in some countries, is the only system in use). A figure for accrued expenses appears when an expense has been incurred by the business in an accounting period but the invoice for that expense has not been received and processed through the business’ accounting system, which means that the amount of the expense has not actually been paid to the supplier of the service or product that gave rise to the expense.
Accrued expenses appear in the current liabilities section of the balance sheet as the amount is still to be paid.
The value of the fixed assets that is shown in the balance sheet is commonly known as the “book” or “net” value which means that it is the original cost of the asset less accumulated depreciation.
In each accounting period an amount of depreciation appears as an expense in the income statement. This figure is the amount of depreciation that is calculated for each individual fixed asset using an appropriate method.
If the business has owned a fixed asset for longer than one accounting period, all the depreciation that has been calculated for that particular asset, and included as an expense in the income statement, is added together and is called accumulated depreciation. This is then deducted from the original cost of the asset to arrive at the book (or net) value. This resulting amount is also known as the net fixed asset value.
Amortization refers to the expensing of the cost of intangible assets over a period of time.
A balance sheet gives a view of a company’s financial position on a particular day, i.e. the last day of the accounting period. While the income statement covers trading activity over a given time period the balance sheet, by contrast, is a static picture (often called a “snapshot”) on that one day only.
Bank balances & cash
In some accounting jurisdictions this is also referred to as “cash and cash equivalents”. This amount would be readily available to the business for use in settling its commitments.
In US balance sheets this is referred to as “notes payable”. This figure represents short-term bank debt repayable on demand. As such, it is the shortest-term liability and appears at the top of the current liabilities section in the balance sheet.
Cash flow statement
The cash flow statement provides historical information on how cash was obtained, how cash was used and how the overall cash position of the business has changed as a result during the accounting period.
Cash paid to suppliers and employees
This is normally the major cash outflow of any business and represents amounts actually paid to suppliers for inventory and to employees in salaries, bonuses etc.
Cash receipts from customers
This represents the amounts actually received from customers as distinct from the level of revenue during the accounting period. Remember that under the accrual accounting system, a sale is recorded as soon as it is made but the cash may not have been received at that point. This figure, then, gives us a realistic picture of the business’ major cash inflow.
These are liabilities that will only become payable by the business should some other event occur. Because the liability is not a real one for the business (the actual amount of the liability may not have been established) until the occurrence of the other event it cannot be accounted for in the balance sheet and so any contingent liabilities should be listed in the notes to the financial statements.
Cost of goods sold
A business has to incur some expenses to enable it to generate its revenue. These expenses could include inventory for a trading business or time-based fees or commissions if it is a service business. These costs will vary with the level of revenue and are known as “cost of goods sold” (also sometimes referred to as cost of sales).
Strictly speaking, “creditors” refers to any person or business that is owed money by the business. We should more specifically focus on trade creditors or trade accounts payable) in our analysis since this relates to the trading operations of the business.
These assets are those that can be expected to be converted into cash within the next accounting period of the business. For most businesses, the major assets that would appear under this heading would be bank balances and cash (sometimes described as cash and cash equivalents), inventory and accounts receivable.
These are liabilities payable within a period of 12 months from the date of the balance sheet and are paid mainly from current assets when those assets convert to cash. Examples of current liabilities are accounts payable (e.g. suppliers), bank overdraft and other short-term debt, tax etc.
Current portion of long-term debt
Long-term debt is payable by the business over a period longer than the usual accounting period. However, in most cases there will be some element of those long-term debts that will be payable within the next 12 months and that element is known as the current portion of long-term debt. By definition, then, it must fall under current liabilities.
Strictly speaking, “debtors” refers to any person or business that owes money to the business. We should more specifically focus on trade debtors (or trade accounts receivable) in our analysis since this relates to the trading operation of the client.
There is a common misunderstanding that income tax is calculated on a business’ net profit figure as shown on its income statement. In fact, the tax computation is entirely separate from the accounting profit calculation.
The business’ taxable income is usually different to the accounting profit in an accounting period because there are various tax allowances that a business can claim that have nothing to do with its income and expenditure situation.
An example of this is the tax allowance on capital equipment. In many cases, the tax allowance on a piece of equipment is different to the accounting depreciation figure that is included in the income statement. Over time this gives rise to a difference between the tax value of an asset and its balance sheet value (i.e. its depreciated value). This difference is usually only temporary and may only become apparent on disposal of the asset at which point there may be an additional tax implication. To recognise this possible tax implication while the asset is still owned by the business, the amount of tax payable or receivable is calculated and described as deferred tax. It may be either an asset or a liability.
This is one type of expense that differs from most of the others and it’s different because there is no transfer of cash involved. Depreciation is an accounting term that refers to the cost of a fixed asset being spread over a period of time, usually the useful life of the asset.
Sometimes also described as retained income, retained profits, or similar. The figure relates to the accumulated profits that have been made in previous accounting periods and which have not been paid (i.e. distributed) to shareholders by way of dividends.
In some accounting jurisdictions profits are referred to as earnings. Even where the term “profits” is in common use, earnings appears in some financial terms such as EBIT (Earnings Before Interest and Tax). Earnings and profits are synonymous
This represents the business’ earnings before interest and tax. It’s a commonly used measure of profitability, especially when comparing one business’ performance with another’s. Note that the terms “earnings” and “profits” are synonymous.
The profit figure that we see in the income statement is an accounting concept which, using generally accepted guidelines, attempts to report the profit made by a business from its activities during the accounting period. What this figure does not take into account, however, is the cost to the business of the shareholders’ equity or capital that was utilised in funding the assets that helped generate the profit. Once this cost is deducted from the accounting profit we are left with the business’ economic profit. For many analysts (and certainly for shareholders), this is a far more important measure of profitability than the accounting profit reflected in the income statement.
These are positive or negative figures that are sometimes found in an income statement after the operating profit figure. They relate to unusual and non-recurring gains or losses that are usually unconnected with the normal day-to-day operations of the business.
Examples would be gains or losses from the sale of a fixed asset.
These form part of the non-current assets found in the balance sheet. They are those assets that tend to have a long-life cycle and are usually defined according to the purpose for which they were acquired by the business. The idea is that these types of assets are utilised in the production of the business’ products and services and are not acquired for re-sale at a profit.
Examples of fixed assets are land and buildings, plant and equipment, fixtures and fittings, motor vehicles etc. Since these assets are held for longer than a single accounting period it is necessary to write-off their cost over their estimated productive lives and this is the process known as depreciation.
Expenses are of two main types; “variable” and “fixed”. Fixed expenses are usually found in the operating expenses and normally relate to those expenses that are incurred irrespective of the level of revenue that the business generates. The word “fixed” in this context does not, therefore, mean that they never change but that they do not change in direct proportion to changes in revenue.
Examples of fixed expenses are salaries, accounting expenses, rent and rates, water and lights, statutory personnel payments, etc.
This figure is often seen in the asset-side of a business’ balance sheet. It arises when a business changes ownership and the new owners purchase the business at a value greater than its net asset value.
Gross profit is the difference between the revenue and the cost of goods sold and gives an indication of the business’ ability to generate a profit from its selling prices after taking into account its direct costs of producing the products or services that were sold.
This refers to the level of profit (or loss) that is attributable to shareholders adjusted to remove the effects of any exceptional (and usually non-recurring) items of revenue and expenditure. It is an attempt to give a reflection of the sustainable earnings of a company, i.e. the company’s earning ability had the exceptional items not occurred. Exceptional items in this case would be transactions of a capital nature that are not related to the ordinary trading activity of the company. This headline earnings figure only appears in the annual financial statements of South African companies.
One of the main objectives of a business is to make a profit and the income statement reflects the financial results of a business’ trading activity over a given period (usually, but not always, 12 months) which is called the accounting period. Information for the accounting period being reported on is required to be shown together with the previous period so that a comparison of performance can be made.
These are assets that are included under non-current assets in the balance sheet and, as their name suggests, do not physically exist. Typical examples of intangible assets are goodwill, patents, licences etc.
Found in the income statement and sometimes described as financing cost. It indicates the amount of interest due to all the providers of long- and short-term interest-bearing debt finance to the business during the accounting period.
Also referred to as stock. This appears in the current assets in the balance sheet and reflects the worth of the inventory valued at the lower of cost or net realisable value (i.e. what the inventory could be sold for).
Operating leases relate to assets that the business uses in its operations and has no intention of acquiring at the end of the lease. An example of this would be an office building. In this case, the lease payments appear in the income statement as an expense.
Financial leases, on the other hand, relate to assets that the business can acquire at the end of the lease period and are, to all intents and purposes, actually owned by the business but financed by a lender. The value of these assets must be capitalised and appear in the balance sheet so that the true value of assets used in the business and the corresponding debt commitment are correctly reflected.
This is debt payable after more than 12 months after the date of the balance sheet. It is normally interest-bearing and will usually give rise to an item found in the current liabilities in the balance sheet called current portion of long-term debt.
Reference to minority interests is often usually found at the bottom of the income statement and in the balance sheet in the shareholders’ equity section. It refers to an outsider’s financial interest in a subsidiary or an associate company of the company whose balance sheet is being analysed.
Net fixed assets
These appear under the non-current assets section of the balance sheet and relate to the long-term, tangible assets of the business such as land and buildings, fixtures and fittings, motor vehicles, equipment etc. When they are described as “net” it means that all the accumulated depreciation up to the date of the balance sheet has been deducted from their original cost of the assets.
Net profit before tax
This profit figure includes all expenses (except for taxation) of the business as well as any exceptional gains/losses. It is common in some jurisdictions to use this profit figure when calculating profitability ratios.
Net working capital
When funds are invested in short-term current assets it is described as working capital. Typically, these assets would primarily be bank balances and cash (or cash and cash equivalents), inventory, and accounts receivable. Some of these assets can be funded through the use of supplier financing (i.e. trade accounts payable), rather than interest-bearing debt and/or shareholders’ equity.
These have a life cycle longer than the normal accounting period (i.e. 12 months) of the business and may include fixed assets such as property, equipment, furniture and fittings, vehicles, etc., as well as items such as long-term loans advanced to others by the business, intangible assets, investments in associate companies and other investments.
These are simply the long-term liabilities of a business. In accounting terms, long-term is defined as those liabilities that are only due to be paid more than one year from the date of the balance sheet. This includes such items as long-term debt, long-term obligations under staff pension and medical aid schemes etc.
These increase the shareholders’ equity in the business but are not available for distribution to shareholders by way of dividends. The reason for this is that, usually, the gain or the profit that gives rise to this reserve has not actually been realised (i.e. it is still only a book figure). An example of this type of reserve is when a fixed property is re-valued at the directors’ request and the new value is higher than the value shown in the balance sheet. The value of the fixed property from then onwards will be reflected at the higher value in the balance sheet and the non-distributable reserve is the corresponding accounting entry.
As the name suggests these are expenses incurred by the business in its normal day-to-day operations and excludes any expenses of a non-operational nature. Examples of fixed expenses are salaries, accounting expenses, rent and rates, water and lights, statutory personnel payments, etc. These expenses are often referred to as fixed expenses.
This gives an indication of how effectively the operations of the business are managed. This profit figure excludes items of an exceptional nature and includes only those income and expenditure items that are directly related to operations.
A set of ratios exist that are designed to measure the profitability of a business. This is slightly different to simply determining whether a business has made a profit; profitability is a measure of how well assets and resources are used to generate profit.
Property, furniture & fittings, equipment and vehicles
These are the fixed assets of the business and appear under the non-current assets in the balance sheet. The intention of the business is to use these assets to enable the business to operate and not to sell them in the short-term to make a profit.
Depreciation is normally calculated on the values of the assets (with the usual exception of land and, sometimes, buildings) and so the values seen in the balance sheet are their net (or book) values, that is, the original cost of the assets less the accumulated depreciation that has been calculated.
Provision for bad debts
Businesses that supply products and services to their customers on credit terms know that, occasionally, a customer is going to fail to pay. To recognise this possibility, prudent managers will make a provision each year for these bad debts which entails deducting a given amount from each year’s profit. It’s important to note that any amount deducted in this way has not actually been lost as a bad debt but is simply being kept aside to meet that eventuality should it arise.
Sometimes also described as retained income, distributable reserves, or similar. The figure relates to the accumulated profits that have been made in previous accounting periods and which have not been paid (i.e. distributed) to shareholders by way of dividends.
Often also referred to as turnover. Revenue is generated through the provision of products and services to customers during the accounting period. The description can vary for different types of businesses depending on their particular trading activity – for example, turnover, sales, fee income, rental income, and commission income, are all variants of this.
This is found on the balance sheet as the first item under the shareholders’ equity section. It could be more correctly described as issued share capital since it represents the nominal (or par) value of the ordinary shares that the company has issued to shareholders. Note that this nominal value bears no relation to the market value of those same shares.
This is found on the balance sheet under the shareholders’ equity section and it arises when shares are issued by the company to shareholders but at a price that exceeds the nominal (or par) value of the shares.
This refers to the financial interest of the shareholders in the business. Equity includes share capital, share premium and profits that have been retained and reserves that have been created.
Also referred to as inventory. This appears in the current assets in the balance sheet and reflects the worth of the stock valued at the lower of cost or net realisable value (i.e. what the stock could be sold for).
This figure appears in the income statement and is the amount of income tax that has been computed based on the profits made during the accounting period and after taking into account any tax allowances available to the business.
This figure appears in the balance sheet under the current liabilities section and represents the amount of income tax that the business has to pay to the tax authorities in the next accounting period.
Also referred to as “trade accounts payable”. These are amounts due by the business to others such as suppliers of inventory and other services. As these trade creditors fall within the current liabilities section of the balance sheet they are, by definition, due to be paid within 12 months from the date of the balance sheet but, in reality, are usually payable within a much shorter time period, probably within a maximum of 30 days.
Also referred to as “trade accounts receivable”. These are amounts due to the business by others, usually its customers. As these trade debtors fall within the current assets section of the balance sheet they are, by definition, due to be paid within 12 months from the date of the balance sheet but, in reality, are usually receivable within a much shorter time period which will be defined by the credit terms that the business allows its customers.
Often also referred to as revenue. Turnover is generated through the provision of products and services to customers during the accounting period. The description can vary for different types of businesses depending on their particular trading activity – for example, revenue, sales, fee income, rental income, and commission income, are all variants of this.
Expenses are of two main types; “variable” and “fixed”. Variable expenses usually make up the cost of goods sold figure since they vary in line with changes in the level of revenue. Examples could be materials costs, packaging, delivery expenses, commissions paid to salespeople, depreciation of manufacturing equipment, etc.