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Basics of key financial terms

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1 Basics of key financial terms
…learn the key financial terms

2 Review of Basic Terms Asset/liability: An asset is an economic resource that a company owns. A liability is a resource that the company owes. Book value/market value: Book value is the amount of an asset or liability shown on the companies’ official financial statements based on the historical, or original, cost. Market value is the current value of the asset or liability. In most cases, book value does not equal market value. Capital goods: These are machines and tools used to produce other goods.

3 Review of basic terms (Cont’d)
Depreciation/amortization: a system that spreads the cost of a tangible asset, such as machinery, over the useful life of the asset. Amortization is a system that spreads the cost of an intangible asset, such as a patent, over the useful life of the asset. Fiscal year: A company’s financial reporting year. In most cases the fiscal year is not the same as the calendar year. Profit margin: This is profit—what the company’s owners keep after paying all the bills—a percentage of sales or revenues. Receivables/payables: Receivables are money owed to the company. Payables are money the company owes to others. Revenue/expenses: Revenue is income that flows into a company. Revenue includes sales, interest, and rents. Expenses are costs that are matched to a specific time period.

4 Finance & Accounts Picture adapted from

5 This will be the case after every single transaction
Accounting Equation Owner’s Equity Assets Liabilities This will be the case after every single transaction

6 We receive revenue for doing scans
What is an Asset? Something we own or use that should generate income. It’s an asset! We bought it We receive revenue for doing scans

7 What is a liability? Something we owe because of something we did and we are going to have to pay. It’s a liability Owe money as we bought on credit Purchase nurses uniforms on credit We are going to pay

8 What is Owner’s Equity? The residual interest in the assets of the entity after deducting all its liabilities. Owner’s Equity Assets Liabilities Is increased by: Revenue and capital contributions Is decreased by: Expenses and drawings/ dividends

9 Overview of the accounting equation
Owner’s Equity Assets Liabilities Assets Liabilities Buildings Accounts Receivable Computer Equipment Motor Vehicles Accounts Payable Accruals Bank Overdraft Long-term Debt Revenue Expenses Government funding Interest received Private Donations Staff Salaries Consumables Electricity Consultants (not always)

10 Accrual accounting Financial reports are prepared on an accrual basis.
Expenses and revenue are recorded when they are incurred or earned, not when cash is paid or received. Example: Purchase of medical supplies Supplies are ordered on the 30 September. They are delivered on the 24 October. Cash paid for the supplies on the 25 November. September October November Goods ordered Goods received Pay creditor

11 Accrual accounting example (Cont’d)
September October November Goods ordered Goods received Pay creditor When the goods are ordered – there is no transaction When the goods were received, the expense was recognised The cash was only paid later, the transaction affecting only the cash balance and the accounts payable / creditor balance.

12 Cash flow vs revenue Income and expenses
Cash flow is the physical cash received or paid out in the running of the business. Revenue and expenses may be recognised when there has been no cash flow. Cash may also be received / paid with no revenue /expense recognition. Income and expenses Income: Any increase in equity resulting from increases in assets or decreases in liabilities Expense: Any decrease in equity resulting from decreases in assets or increases in liabilities

13 Key terms

14 Costs Fixed (Indirect/Overheads) – are not influenced by the amount produced but can change in the long run e.g., insurance costs, administration, rent, some types of labour costs (salaries), some types of energy costs, equipment and machinery, buildings, advertising and promotion costs Variable (Direct) – vary directly with the amount produced, e.g., raw material costs, some direct labour costs, some direct energy costs Semi-fixed – where costs not directly attributable to either of the above, for example, some types of energy and labour costs

15 Total Costs (TC) = Fixed Costs (FC)+ Variable Costs (VC)
Average Costs = TC/Output (Q) AC (unit costs) show the amount it costs to produce one unit of output on average Marginal Costs (MC) – the cost of producing one extra or one fewer units of production MC = TCn – TCn-1

16 Revenue Total Revenue – also known as turnover, sales revenue or ‘sales’ = Price x Quantity Sold TR = P x Q Price – may be a variety of different prices for different products in the portfolio Quantity – could be global sales

17 Profit Profit (Π) = TR – TC
Normal Profit – the minimum amount required to keep a business in a particular line of production Abnormal/Supernormal Profit – the amount over and above the amount needed to keep a business in its current line of production

18 Break Even

19 Occurs where Total Costs = Total Revenue
Break Even Occurs where Total Costs = Total Revenue Start-up costs – fixed costs Running costs – variable costs Revenue stream depends on price charged ‘Low’ price – need to sell more to break-even ‘High’ price – lower level of sales required before breaking even Fixed Costs Break-Even Point = Contribution

20 Purpose of Accounts

21 Purpose of Accounts Provide information for stakeholders – customers, shareholders, suppliers, etc. Provides the opportunity for the business to monitor its own activities Provides transparency to enable the firm to attract investment Reduces the chance for fraud – not 100% successful!!

22 Financial statements Provide important information about the value of the firm. Three most relevant: Balance sheet Profit and loss statement (income statement) Cash flow statement Financial analysts and managers learn how to rearrange financial statements to squeeze out the maximum amount of information (using so-called financial analysis)

23 Financial Statement Analysis
The objective is to show how to rearrange information from financial statements into financial ratios that provide information about five areas of financial performance: Short-term solvency: measure the ability of the firm to meet recurring financial obligations (that is, to pay its bills). Activity: measure how effectively the firm’s assets are being managed. Financial Leverage: related to the extent to which a firm relies on debt financing rather than equity. Profitability: measure the extent to which a firm is profitable. Value: One very important characteristic of a firm that cannot be found on an accounting statement is its market value.

24 Profit and loss account - Flow

25 Profit and Loss Account (income statement)
Shows the flow of sales and costs over a period Shows the level of profit or loss made Shows what has been done with the profit or loss

26 Income statement – Key terms
Sales Income generated by the sales of goods and services for the specified period. Sales are often categorized by the product sold. Cost of Goods Sold (COGS) Value of the inventory that was sold. It also is often categorized by the product sold. Gross Margin Gross Margin = Sales – Cost of Goods Sales Expenses Expenses incurred to generate or complete the period’s sales. Administrative & General Expenses Expenses incurred to carry out the management and administrative function of the organization. Many of these expense are incurred whether or not any sales are made. Net Income – is the earning (losses) generated for a period. Net Income = Revenue – COGS – Sales Exp – Adm/Gen. Exp.

27 Balance Sheet - Snapshot

28 Balance Sheet A snapshot of the firm’s position at a point in time
Shows what a company owns (assets) and what it owes (liabilities) Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)

29 Balance Sheet Terms Assets
All the resources owned by the firm as of the date of the balance sheet. Current assets All the resources which are or will be turned into cash or used up by the firm within the year. Cash Cash on hand or on deposit with a financial institution with a term of less than one year. Accounts Receivable Money owed to the firm usually by customers who have set repayment terms (15 or 30 days to pay). Prepaid expenses Expenses that have be paid in the current accounting period, but all or part of them will apply to the next accounting period. Inventory The value of goods on hand including all costs in securing or processing the goods. Goods are valued at the lower of cost or market value.

30 Balance Sheet Terms (Cont’d)
Investments Deposits being held for more than one year or investments in other organizations. Fixed Assets Assets of an organization that are used up over a number of accounting periods (years). Fixed assets are not charged against income at the time of purchase because of the long term nature of the investment made. Instead depreciation (an expense item) is used to account for the portion of the asset used each year. Liabilities Debts of the organization, what the organization owes its creditors. Current liabilities Debts payable within the next year. Accounts payable Amount owing to trade suppliers. Accrued liabilities Other expenses such as holiday pay which have not been paid at the end of the accounting period.

31 Balance Sheet Terms (Cont’d)
Owners’ Equity The members’ share of ownership of the assets of the organization Assets – Liabilities = Owners’ Equity Share Capital The members’ direct investment in the organization as an owner. Line of Credit An bank account overdraft provision that has been pre-arranged with a financial institution. Demand Loans Loans received by organization that are used to finance the firm’s assets and are repayable with set terms. However default on the payment of conditions makes the loans immediately repayable (payable on demand by the financial institution). Retained Earnings The cumulative earnings (losses) from previous accounting periods that have be retained by the firm to support its financial viability and long term development. Current Earning The earnings (losses) generated in the current accounting period.

32 Key financial terms Other terms like the ones related to cash flows, taxes, financial instruments, budgeting will be introduced gradually during the course (in other and specifically dedicated training sessions).

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