MBA Finance Important Terms

Net worth Net worth is the amount by which assets exceed liabilities. Another way to say this is, it’s the value of everything you own, minus all your debts. Net worth is a concept that can be applied to both individuals and businesses, as a measure of how much they are really worth. In the corporate world, net worth is also called book value or shareholders’ equity. The word “net”, in financial language, means “after subtracting expenses and debts.” Assets These are the economic resources a business has, including the products it has in inventory, the office furniture and supplies purchased for use, and any trademarks or copyrights it owns. These assets count toward the value of a business, since they could be sold if the business experienced difficult times. Liabilities This includes any debt accrued by a business in the course of starting, growing and maintaining its operations, including bank loans, credit card debts, and monies owed to vendors and product manufacturers. Liabilities can be divided into two major types: current, which refers to immediate debts (e.g. money owed to suppliers), and long-term debt, which refers to liabilities (e.g. loans and accounts payable). Expenses Business expenses are the costs the company incurs each month in order to operate, including rent, utilities, legal costs, employee salaries, contractor pay, and marketing and advertising costs. To remain financially solid, businesses are often encouraged to keep expenses as low as possible. Cash Flow Your cash flow is the overall movement of funds through your business each month, including income and expenses. Businesses track general cash flow to determine long-term solvency. A business’ cash flow can be determined by comparing its available cash balance at the beginning and end of a specified period. Bottom Line This is the total amount a business has earned or lost at the end of the month. The bottom line is the last financial figure on a ledger. The term can also be used in the context of a business’ earnings either increasing or decreasing. Capital Gains The increase in the value of an asset or investment — like a stock or real estate — above its original purchase price. The gain, however, is only on paper until the asset is actually sold. A capital loss, by contrast, is a decrease in the asset’s or investment’s value. You pay taxes on both short-term capital gains (a year or less) and long-term capital gains (more than a year) when you sell an investment. By contrast, a capital loss could help reduce your taxes. Rebalancing  The process of buying or selling securities over time in order to maintain your desired asset allocation. For example, if your target allocation is 60 percent stocks, 20 percent bonds and 20 percent cash, and the stock market has performed particularly well over the past year, your allocation may now have shifted to 70 percent stocks, 10 percent bonds and 20 percent cash. To rebalance your portfolio, you could sell some of your stocks and reinvest the proceeds in bonds, or invest new money in bonds to bring the portfolio back to the original balance. Stocks  Also called equities or shares, stocks give you ownership in a company. When you buy stocks, you become a company shareholder, giving you a claim on part of that company’s assets and earnings. The two main types of stocks are common and preferred. If you hold common stock, you can vote at shareholders’ meetings and receive dividends — however, you’re also lowest on the totem pole in the corporate ownership structure. Preferred stockholders have a higher claim on assets and earnings than owners of common stock (for example, they receive their dividends first), but they don’t have voting rights. Bonds  Commonly referred to as fixed-income securities, bonds are essentially debt investments. When you buy a bond, you lend money to an entity, typically the government or a corporation, for a specified period of time at a fixed interest rate (also called a coupon). You then receive periodic interest payments over time, and get back the loaned amount at the bond’s maturity date. Compound Interest  When you’re investing or saving, this is the interest that you earn on the amount you deposit, plus any interest you’ve accumulated over time. When you’re borrowing, it’s the interest that is charged on the original amount you are loaned, as well as the interest charges that are added to your outstanding balance over time. Think of it as “interest on interest”. It will make your savings or debt grow at a faster rate than simple interest, which is calculated on the principal amount alone. Financial Report A financial report is a comprehensive account of a business’ transactions and expenses, created to give a business oversight of its financial matters. A financial report may be prepared for internal use or external sources, such as potential investors. Financial Statement Similar to a financial report, a financial statement lists all of a business’s financial activities. However, a financial statement is generally a more formal document, often issued by a lending institution. Cash Flow Statement A cash flow statement shows the money that entered and exited a business during a specific period of time. It generally covers four main categories: operating activities, investing activities, financing activities and supplemental information. Income Statement Also known as a “profit and loss statement,” an income statement shows the profitability of a business during a period of time. The income statement looks at a business’ revenues and expenses through all of its activities. Download a free income statement template here. Balance Sheet A business’ balance sheet gives a snapshot of the company’s financial situation at a given moment. This includes the cash it has on hand, the notes payable it has outstanding and owner(s) equity in the business. Download a free balance sheet template here. Profit and Loss To remain financially healthy, a business must have a regular profit that exceeds its losses. Profits and losses are usually itemized on a profit and loss statement, also known as the income statement defined above. Capital In business finance terms, the money a business has in its accounts, assets and investments is known as capital. In business, there are two major types of capital: debt and equity. Accounts Receivable Accounts receivable (A/R) is the amount a business is owed by its clients. Usually the client is notified by invoice of the amount owed, and if not paid, the debt is legally enforceable. On a business’ balance sheet, accounts receivable is often logged as an asset. Depreciation Over time, a business’ assets decrease in value due to the time that has passed since it was purchased. For tax purposes, a business can recover the cost of that depreciation through a deduction.