Finance Terms UK

What does current ratio mean?

Current ratio compares a company’s current assets to its current liabilities, essentially measuring a company’s ability to fulfil short-term financial obligations. It’s a good indicator of financial health and can warn of impending issues if the ratio is too low or even too high.

A company’s current ratio should be roughly in line with industry averages, as a ratio that’s too high could indicate that assets are being used inefficiently, while a low ratio could mean financial or management problems.

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Key takeaways from this section:

• Current ratio compares a business’s current assets with its current liabilities and shows its ability to pay short-term debts.
• When using current ratio to assess a company’s financial health, it should be taken in context with past performance and other similar companies in the same industry.
• Current ratio only provides a surface-level look at the financial health of a company, and further analysis is needed to understand the nature of current assets and how easily liquidated they are.

What is compound interest?

Compound interest is a very common concept in the world of finance, and refers to the interest on savings being applied based on the initial sum as well as the accumulated interest from previous periods. It can be thought of as earning interest on interest, meaning a pot of money can grow quicker than with standard interest.

The rate of interest accrued depends on the period set, whether that’s annual, quarterly, or monthly, for example. Naturally, with a more frequent interest period, such as every month, the amount accumulated would go up faster, earning more money more rapidly.

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Key takeaways from this section:

• Compound interest on savings is worked out based on the initial deposit plus all the interest already accumulated.
• The rate of compounding depends on the frequency of the period, such as monthly or annually.
• Make the most of compound interest by saving early and leaving the amount untouched for as long as possible
• Compound interest can work against you when borrowing, such as debt quickly building up on a credit card when the full amount isn’t paid off.

What is a profit & loss statement?

A profit and loss statement is an important document for a business that acts as a financial statement. Also shortened to P&L statement, and similar to income statements, this document reports on the costs, expenses and revenues accrued over a selected time frame. It can act as a helpful indicator of the financial health of a business, enabling strategy teams to plan for the future.

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Key takeaways from this section:

• The profit and loss statement is a document that businesses release yearly or quarterly depending on their business approach and industry. It acts as report on the revenue made by the business in that time, as well as the business costs accrued through expenses.
• The profit and loss statement is one of three key reports which are released by a business in a year or a quarter – the other two are the balance sheet and the cash flow statement.
• These three documents together, and when compared to other years and periods, can give a clear picture of the financial health of a business.

What is quick ratio?

Quick ratio, sometimes knows as the quick assets ratio or the acid test, is a way to identify and indicate a company’s short-term liquidity – its ability to meet it’s short-term obligations.

Quick ratio helps to measure a company’s ability to meet its short-term obligations with its most liquid assets. In this case, assets can include cash, accounts receivable, marketable securities, short-term investments and inventory. These assets are known as quick assets as they can easily and quickly be converted into cash.

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Key takeaways from this section:

• Quick ratio is a way of measuring a company’s ability to meet its short-term obligations with its most liquid assets.
• Quick ratio measures a company’s capacity to pay its current liabilities without needing to sell its inventory or have to obtain additional financing from elsewhere.
• To understand whether the quick ratio is good – the higher ratio results mean the company’s liquidity and financial health is good as opposed to a lower ratio.
• Quick ratio will differ for businesses in different sectors – some may have lower ratios on average whilst others will have a higher score. Always compare with what is considered to be the norm in your specific industry.

What is fiscal policy?

Fiscal policy refers to a government’s approach to public spending and taxation, and how these influence economic conditions such as inflation, employment, and demand for goods and services.

Generally, fiscal policy is used to promote and stimulate economic growth while reducing poverty, or it’s used reactively to mitigate the effects of global economic shocks or downturns.

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Key takeaways from this section:

• A fiscal policy is how a government influences economic conditions through public spending and taxation policies.
• Fiscal policy is largely based on Keynesian economics, based on ideas from the economist John Maynard Keynes.
• Governments can employ expansionary or contractionary fiscal policies to counteract the effects of economic downturns or restrain runaway economic growth and inflation.

What is debt to equity ratio?

The debt to equity ratio, also known as risk ratio, is a calculation used to appraise a company’s financial leverage based on its shareholder equity. It measures how much a company is financing its activities through debt rather than owned cash, and whether a business would be able to cover its debts with shareholder equity if there was a sudden downturn or other financial shock.

This makes it different to the debt-assets ratio which uses a business’s total assets as a denominator, and instead highlights how a company’s finances are balanced between debt and equity financing.

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Key takeaways from this section:

• The debt to equity ratio shows a company’s financial leverage by comparing its total liabilities to its shareholder equity.
• A high debt to equity ratio can show a higher risk to investors and shareholders.
• Debt to equity ratios can look very different across different industries and types of business, so aren’t always easy to compare

What is a balance sheet?

Similar to bank statements, balance sheets are a financial statement that reports a company’s assets, liabilities and owners’ equity at a particular point in time. Balance sheets help to illustrate a business’s net worth.

The balance sheet is, in essence, a financial statement that provides a snapshot into what a company owns and owes, as well as the amount that is invested by shareholders. It’s used by businesses – alongside other important financial statements such as the income statement or bank statement – to conduct fundamental analysis or calculating financial ratios.

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Key takeaways from this section:

• A balance sheet is a financial statement that reports a company’s assets, liabilities and shareholders’ equity
• Balance sheets are one of the three main financial statements that are used to evaluate a business – alongside the income statement and the statement of cash flows.
• The balance sheet is a snapshot into a company’s finances and illustrates a business’s net worth.
• Balance sheets can also help business stakeholders and analysts evaluate the overall financial position of a company.

What is a bank statement?

A bank statement is a document that details and summarises all your transactions, and is prepared and sent to you by your bank at the end of every month. It summarises everything from deposits and withdrawals to any service charges, and shows your ending balance after all the transactions of the month.

These statements help you to learn more about your financial habits and gives you a detailed breakdown of your monetary habits and spending. It can help you to recognise spending habits and track finances, identify any errors or discrepancies to help reduce fees etc and much more.

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Key takeaways from this section:

• Your bank statement is a summary of all your financial activity for a set time period, usually monthly.
• Bank statements will also include a beginning and ending balance for the time period it encompasses.
• Bank statements will detail all of your transactions to help you track finances, identify potential fraud and help to manage fees.
• Account holders will have the option of receiving a physical copy of their statement through the post or an electronic version via email.

What is working capital?

Working capital is a measure of a company’s financial health and shows the difference between current assets and current liabilities. It demonstrates liquidity and operational efficiency, and the potential for a business to invest in growth and expansion as well as meeting its current financial obligations.

It’s calculated by taking all current assets and liabilities into account, which includes elements such as cash, stock inventories, and raw materials, as well as interest on debts, taxes, and supplier bills.

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Key points about working capital:

• Working capital is the amount a company has available to cover its everyday operations as well as invest in future growth.
• Working capital can be calculated by dividing a company’s current assets by its current liabilities.
• It’s a measure of short-term financial health that shows liquidity and operational efficiency, though can also highlight potential problems if it’s consistently very high.

What is a business model?

A business model refers to a company’s plan to ensure successful operation and profitability. A good business model will detail and identify sources of revenue, the intended customer base, products and services to push and sell and any other details of financing.

It's important to always have a business model set regardless of whether you are a small or big business, newly founded or a well-established business. The business model will help set out your commercial plans, stay ahead of any changes that may need to be implemented, recruit new talent if needed, attract investment, anticipate upcoming trends and challenges, and much more. Business models also help investors to easily evaluate any companies that interest them.

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Key takeaways from this section:

• At its core, a business model is a company’s strategy for profitably and successful operation.
• Business models will generally vary for different companies and industries, but generally will include the same elements such as information about the products and services the business intends to sell, target markets, anticipated expenses etc.
• The main two levers of a business model are pricing and costs.
• Business models helps businesses to understand, design and test business assumptions and decisions in the marketplace, and can help to unlock long-term value.
• There are over 50 different types of business models that can be used, so find the one that is best suited to the nature and the needs of your specific company.

What is capital employed?

Capital employed, also known as funds employed, is a figure commonly used to measure a company’s profitability and efficient use of capital.

Capital employed is typically the total amount of capital that is used for the acquisition of profits by a firm or particular project. It can also be used to refer to the value of all of the assets that are used by a company in order to generate earnings.

Capital employed is helpful in the sense that it can be used alongside other financial metrics in order to properly determine aspects such as the return on a company’s assets or to see how effective management is at utilising capital.

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Key takeaways from this section:

• Capital employed is a way to tell how much money has been put to use in an investment.
• Simply put, capital employed is the total amount of funds that are deployed to run the business in order to generate profit.
• The figure commonly used to calculate capital employed is: Total assets – current liabilities = Equity + Noncurrent liabilities.

What is gross margin?

Gross profit margin, also known as gross margin, is a financial metric used to measure just how effective and efficient a business is at managing its operations. The gross margin is the sales revenue that a company retains after incurring the direct costs that are associated with producing the goods it sells and services it provides.

Gross margin helps to indicate the performance of a company’s sales based on the efficiency of its production process. The financial ratio is used by managers to assess and determine the efficiency of the production process for a product or service sold by the company, and is based on the company’s cost of goods sold.

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Key takeaways from this section:

• Gross margin is a valuable financial measurement that helps to indicate the efficiency with which the business can produce and sell their products or services.
• Gross margin is based on the company’s cost of goods sold – the direct costs of producing the company’s products or services.
• The gross profit margin is a measurement that is highly valued by managers and also potential investors of a company as it is an accurate way of calculating business efficiency.
• The gross margin shows the amount of profit made before deducting selling, general and any admin costs.

What is an intangible asset?

Intangible assets are those assets that are not typically physical in nature and have no material substance. Almost all intangible assets will have no physical form but will provide value to businesses and their owners.

Intangible assets can be found in all areas of a business from technology to customer relationships, and exist alongside tangible assets (land, vehicles, equipment and inventory). Financial assets such as stock and bonds can also be referred to as tangible assets.

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Key takeaways from this section:

• Intangible assets are assets that are not physical in nature but are still of value and importance to businesses.
• They can include aspects such as a patent, brand, trademark, copyright etc.
• Intangible assets that are created by a company will not appear on a balance sheet and have no recorded book value.
• Businesses can either create or acquire intangible assets, and they can be considered both definite and indefinite.

What is liquidity ratio?

A liquidity ratio is a measurement which is used to indicate whether a debtor will be able to pay their short-term debt off with the cash they have readily available, or whether they’ll need to raise additional capital to cover the amount. This kind of metric can also show how swiftly the assets held by the debtor can be turned into cash for the debt.

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Key takeaways from this section:

• Liquidity ratios are types of ratios that show a company’s ability to pay off short-term debts from its cash.
• There a number of different liquidity ratios that creditors and debtors use to establish metrics about the liquidity of a business and its coverage of short-term debts.
• Liquidity ratios can give an idea of the financial health of a business, though they’ll rarely tell the whole story. Full analysis is needed to establish a full picture of the state of a company’s finances.

What is return on equity?

Return on equity (ROE) is a financial measure that provides investors with insight into a company’s profitability in relation to stockholder equity. It shows how a company is managing the money shareholders have contributed, with a higher ROE demonstrating good management and a healthy income and growth from equity financing.

Return on equity is a valuable metric when comparing a company to competitors in its industry, highlighting which businesses are operating with the greatest financial efficiency and offering the best potential for investors.

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Key takeaways from this section:

• Return on equity (ROE) is a financial measure that shows how efficiently a company is managing it shareholder investments.
• Calculate ROE by dividing a business’s net income by shareholder equity.
• ROE can be assessed by comparing to industry and peer averages.
• It is better to have an ROE that is the average, or slightly higher than the average of your business’ peers. A too high ROE can be an indication of risk.

What is a return on investment?

Return on investment is a performance measure used to calculate exactly how effective your investments into your business are at generating income. ROI measures the profitability of investments and helps to compare the efficiency of multiple different investments.

As the name suggests, return on investment is a method used to measure the amount of return that can be made on a particular investment and how this compares and relates to the initial investment cost.

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Key takeaways from this section:

• ROI stands for Return on Investment and is used to measure how much financial benefit you will receive from a particular investment for your business.
• To calculate ROI, you will have to divide the overall net benefit of an investment by the actual cost of the investment.
• ROI is not static and so for the best outcome, it is better to calculate it regularly for every notable investment.
• ROI should be calculated when you invest both time and money into your business.

What is supply chain management?

Supply chain management is, simply put, the management of the flow of goods and services and includes all the processes that transform raw materials into final products. Supply chain management handles the entire production flow of any good or service – beginning from the raw components all the way through to the delivery of the final product.

Supply chain management involves streamlining a business’s supply-side activities in order to maximise customer value and gain a competitive advantage in the marketplace.

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Key takeaways from this section:

• Supply chain management is the management of the flow of goods and services that encompasses all processes that lead to the transformation of raw materials into final products.
• Supply chain management is a procedure that helps to reduce extra costs, improve efficiency, increase revenue and deliver products through the system faster.
• A good and effective supply chain helps to benefit the company and save them from expensive recalls and lawsuits.

What is net income?

Net income, which is also sometimes referred to as net earnings, is revenue minus expenses, interest and taxes. It is essentially the same as the overall profit of a business or its earnings, and is an indicator of a company’s profitability.

Net income is calculated as sales minus the cost of goods sold, selling, general and admin expenses, operating expenses, depreciation, interest, taxes and any other expenses. It’s a useful number for both managers and investors to be aware of in order to assess and understand how much revenue exceeds the overall expenses of the organisation.

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Key takeaways from this section:

• Net income is calculated as revenue minus expenses, interest and taxes.
• Net Income represents an individuals or business’ total earning or pre-tax earnings after accounting for deductions and taxes in gross income.
• Net income is used to determine and measure a company’s profitability over time, and can help with setting future goals for revenues etc.
• If expenses and other reductions are greater than the actual income of the business, this will indicate a net loss.

What is opportunity cost?

Opportunity costs are what investors and investing businesses used to describe the gains or benefits that those investors and businesses lose out when they choose one opportunity over the other. The concept is part of microeconomic theory which focuses on the decision-making that comes from working with scare resources.

Put simply, the opportunity cost represents the benefit that might have been gained if the alternative opportunity had been taken. The opportunity cost is the cost the business misses out on for these missed benefits.

Investors and businesses use opportunity costs to establish what the best course of action, or the best decision, is to make. Each opportunity cost gives an idea of what might be missed out on by pursuing one option, so this is weighed against the potential gains to indicate the best route forward.

Opportunity costs, by their own nature, are sometimes difficult to discern in the decision-making process, but identifying them is integral to making the right choice.

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Key takeaways from this section:

• Opportunity cost is the value of the next best alternative to the choice a business can make.
• Opportunity cost is worked out by subtracting the returns you’ll make with the choice you’ve made, from the returns you could have made from the next best alternative.
• Opportunity cost is one of the key metrics a business will look at when making any kind of business decision, from taking on new liabilities to making new investments.

What is Pro Rata?

Pro rata essentially means allocating something in equal proportions, or ensuring someone is receiving their fair share. It’s a Latin term that translates to ‘in proportion’, and it’s most often used in the world of business finance and salaries.

Pro rata calculations are used in areas such as dividend payments paid to shareholders, interest earned on investments, or working out annual premiums for contracts that are used for less than the full term. This term also often appears on job adverts, describing the salary as pro rata.

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Key takeaways from this section:

• If something is done pro rata, it means it’s divided up or assigned proportionately.
• Prorating something means working out a reduced cost as a proportion of the whole, such as a discount on an insurance policy that’s used for less than the full standard term.
• The use of pro rata can apply to things like salaries, dividends, billing for services, and more.

What is liquidity?

Liquidity describes a business or person’s ability to easily convert assets into cash to spend or invest as needed. Cash itself is naturally the most liquid of assets, as it’s immediately ready for use and can be disposed of at its market value in exchange for other assets.

Types of asset that could be liquidated includes anything that provides a current, future, or potential economic benefit, such as stock, retail inventory, property, and investments.

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Key takeaways from this section:

• Liquidity represents how easy it is to convert an asset at its market value.
• Cash is the most liquid asset as it can be easily and quickly used to obtain other assets.
• Strong liquidity is important for a market or business so goods can be converted without losing their value.

What is insolvency?

Insolvency is a situation that occurs when a company or individual can’t pay their debts or creditors in full when they are due. A company can be classed as insolvent when its debts outweigh its assets, though this doesn’t necessarily mean the business cannot recover. Insolvency is also different to bankruptcy.

Before the state of insolvency is made formal, there is often a period of informal arrangements with creditors to try and find a way for the debts to paid without the business folding.

The risk of insolvency can arise for many different reasons, including a loss of cashflow from poor sales or other factors, an increase in costs from production or materials, or poor financial management.

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Key takeaways from this section:

• Insolvency occurs when a company or person is unable to pay off debts that are due.
• It’s a state of financial distress that can be resolved by making arrangements with creditors to pay off debts and doesn’t always lead to bankruptcy.
• Insolvency can happen due to many reasons, such as external factors that reduce cashflow, or poor financial management.

What is gross income?

Gross income refers to the total pay an individual receives before taxes and other deductions, and can also refer to the gross income of an organisation or business. For an individual’s salary, gross income will appear on their payslip, showing the total amount of income for a specific period. More generally it refers to all sources of income for an individual, including from property and services.

For a business, gross income can also be called gross profit or margin and includes all revenue sources minus the cost of the goods or services sold.

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Key takeaways from this section:

• An individual’s gross income includes salary or wages, and other sources of income, before tax and other deductions.
• A business’s gross income includes all sales of goods or services minus the direct cost of providing those goods.
• As an individual, your gross income can be used by lenders to determine eligibility for credit.

What is the cash conversion cycle?

The cash conversion cycle (CCC) is a critical metric that businesses use to evaluate their financial performance. Understanding the cash conversion cycle is essential for managing cash flow effectively and optimising a company's financial operations. In this blog, we will explore the concept of the cash conversion cycle and how it can be used to analyse a company's financial health.

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Key takeaways from this section:

• The cash conversion cycle (CCC) is a metric that measures the amount of time it takes for a company to convert its inventory and other resources into cash flow.
• A negative CCC indicates that a company is able to convert its resources into cash flow more quickly than it takes to pay its suppliers, which can be a sign of good financial health.
• A positive CCC indicates that a company takes longer to convert its resources into cash flow than it takes to pay its suppliers, which can be a sign of financial risk.

What is working capital management?

Working capital management is the process of managing a business's short-term assets and liabilities to ensure it has enough cash to meet its financial obligations. It involves managing your current assets and current liabilities.

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Key takeaways from this section:

• Working capital management is essential for the success and sustainability of any business.
• It enables businesses to manage their short-term cash flow requirements and meet their financial obligations.
• Effective working capital management involves managing current assets and current liabilities, forecasting cash flow requirements, and implementing strategies to improve working capital.

What is accounts payroll management?

Managing your business's finances is critical to its success. One key aspect of financial management is accounts payable management. In this article, we'll discuss what accounts payable management is, why it's important, and how to manage your accounts payable effectively.

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Key takeaways from this section:

• Accounts payable management is the process of managing and paying the money that your business owes to suppliers, vendors, and other creditors.
• Effective accounts payable management is important because it can help you improve your cash flow, build strong relationships with suppliers, and avoid late fees and penalties.
• Examples of how to manage your accounts payable include negotiating payment terms, implementing an approval process for invoices, and using technology to automate the payment process.

What is debt service coverage ratio?

Debt-service coverage ratio is a widely used indicator of a company's financial health, especially for businesses carrying a significant amount of debt. The ratio compares a company's total debt obligations (including principal repayments and some capital lease agreements) to its operating income.

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Key takeaways from this section:

• DSCR is an important measure of a company's financial health.
• Lenders, stakeholders, and partners will target different DSCR metrics.
• DSCR can vary based on industry, company history, and other factors.

What are revolving credit facilities?

A revolving credit facility is a type of financing arrangement that provides businesses with access to a predetermined credit limit. Unlike traditional term loans, revolving credit facilities enable businesses to borrow and repay funds flexibly within the established limit.

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Key takeaways from this section:

• Revolving credit facilities provide businesses with flexible access to funds within a predetermined credit limit.
• Establishing a positive relationship with lenders through responsible utilisation of revolving credit facilities can benefit businesses in the long term.
• Applying for a revolving credit facility involves thorough research, gathering documentation, submitting applications, and reviewing/negotiating terms.

What is commercial property finance?

Commercial property finance refers to the funding and financing options available to individuals and businesses for the purchase, development, or refinancing of commercial properties.

It plays a crucial role in the real estate market, enabling investors to acquire and expand their property portfolios. Commercial properties can include office buildings, retail spaces, industrial facilities, and more.

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Key takeaways from this section:

• Commercial property finance provides funding options for purchasing, developing, or refinancing commercial assets, playing a pivotal role in the real estate market.
• Key considerations in commercial property finance include loan types, interest rates, lender selection, Loan-to-Value ratio, and the documentation and approval process.
• The benefits of commercial property finance encompass leveraging for asset growth, diversification of real estate portfolios, potential for higher rental incomes, and several tax advantages.