A simple guide to understanding confusing finance and business speak
The evidence from surveys dealing with women’s financial literacy and confidence has shown that many of us feel intimidated by financial concepts – and that includes the language of business. Here are a few definitions of oft used business terms to help you unpick ‘the speak’.
If you’re planning to start, maintain and grow a business, then understanding the power of these economic devices is important.
Difference between Statutory Profit and Cash Earnings
Statutory Profit – (also known as Reported Profit) is recorded on financial statements (e.g. the annual report) and must adhere to relevant accounting standards and other disclosure regulations – SP includes all financial impacts including one-offs and infrequent items that impact profit.
Cash Earnings or Underlying Profit – is an adjusted position showing what is believed to be an accurate position of the company’s profit position and can exclude one-time charges or infrequent events as these are not considered part of ongoing business performance.
Return on Equity (ROE)
ROE is a key measure of performance. It measures a company’s profitability by showing how much profit a company can generate with the amount of money shareholders have invested.
Fully franked dividend
When any company issues fully franked dividends, effectively tax has already been paid (at the corporate tax rate) by the company so as shareholder receiving a fully franked dividend you will be entitled to receive a tax credit (also known as an imputation credit or a franking credit) for the amount of tax already paid.
Basis points, otherwise known as “bps” are a unit of measure used to describe the percentage change in a rate. One basis point is equivalent to 0.01%. For example, a movement in margin from 2.31% to 2.35% represents an increase of 4bps.
Productivity is defined as the efficient use of resources, labour, capital, land, materials, energy, information, in the production of goods and services. Higher productivity means accomplishing more with the same amount of resources or achieving higher output in terms of volume and quality from the same input. Largely relate to savings – either cost savings from improving the efficiency of a process, system or labour (reducing time or effort to do an activity).
The gross margin represents the total revenue that the company retains after incurring the direct costs associated with producing the goods/services it sells.
Jaws is a profitability measure. It is the difference between Revenue growth % and Expense Growth % over the same period. For e.g. if revenue growth is 5%, and expense growth is 3%, we have positive jaws of 2%. Positive jaws shows revenue is growing at a faster rate than expenses. Negative jaws signals revenue growth is growing at a slower rate than expenses. Negative jaws does not mean the organisation is not making a profit, it’s an indicator of strength of performance, you can have negative jaws and still be profitable.
Profit and Loss Statement (P&L)
This is one of the main standard financial statements in which organisations have to disclose as part of the external reporting requirements.
Payback Period (PP)
The payback period is the length of time required to recover the cost of an investment. The payback period is expressed in years and fractions of years. For example, if a company invests $600,000 in a new production line, and the production line then produces positive cash flow of $200,000 per year, then the payback period is 3.0 years. The payback period of a given investment/project is an important determinant of whether to undertake a project, as longer payback periods are typically not desirable as it will take longer to see the financial benefit.
Return on Investment (ROI)
Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. It generally measures the gain/loss generated relative to the amount of money invested. A high ROI means the investment gains compare favourably to the cost. Most commonly measured as net income (income less cost) divided by original cost of the investment, or capital gain divided by original cost.
An asset quality rating is an evaluation assessing the credit risk of a particular asset. These assets usually require interest payments — such as loans. The quality of assets helps in determining how assets are managed. As asset quality goes up, benefits include more liquidity, greater risk capacity, and a lower cost of funds (COF). All of which can lead to higher valuation levels. High asset quality implies low probability of default/loss on that asset and there are various metrics to measure this. For example: Gross impaired assets to gross loans – this measures the proportion of impaired loans to total gross loans.
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit.
A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. This gives investors an idea about what the company owns and owes, as well as the amount invested by shareholders. The Balance sheet equation is Total assets equals liabilities plus owner’s equity. Looking at the equation in this way shows how assets were financed: either by borrowing money (liability) or by using the owner’s money (owner’s or shareholders’ equity). Balance sheets are usually presented with assets in one section (on the left) and liabilities and Shareholders’ Equity (on the right) with the two sections “balancing”.
A liability is a company’s financial debt or obligations that arise during the course of its business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Recorded on the right side of the balance sheet, liabilities include loans payable, accounts payable, mortgages, deferred revenues and accrued expenses.
In simple terms this is the measure of the ability of a debtor (an entity that owes a debt to another entity) to pay their debts as and when they fall due.
Holding assets in a highly liquid form tends to reduce the income from that asset (cash, for example, is the most liquid asset of all but pays no interest) so banks will try to reduce liquid assets as far as possible. However, a bank without sufficient liquidity to meet the demands of their depositors risks experiencing a bank run. The result is that most banks now try to forecast their liquidity requirements and maintain emergency standby credit lines at other banks. Banking regulators also view liquidity as a major concern and in recent times further regulation has been enforced across Banking & Finance.
This is the interest rate which banks pay to borrow funds from other banks in the money market on an overnight basis. Decisions regarding the cash rate target are made by the Reserve Bank Board and released to the market the first Tuesday of each month. The change in the cash rate is a monetary policy lever which the RBA will employ in response to other macro-economic factors – including speed of inflation, consumer and business sentiment – to either stimulate the economy or slow the rate of growth to stem inflation.
Market share represents the percentage of an industry or market’s total revenue that is earned by a particular company over a specified time period. Market share is calculated by taking the company’s revenues over the period and dividing it by the total sales of the industry over the same period. This metric is used to give a general idea of the size of a company in relation to its market and its competitors.
This post was written by Westpac’s Ruby Connection and is republished here with permission.