Glossary of Common Business Terms
As a business manager, it is extremely helpful to familiarize yourself with common business terminologies as follows:
"Acid Test" Ratio - Cash plus those other assets that can be immediately converted to cash should equal or exceed current liabilities. The formula used to determine the ratio is as follows: cash plus receivables (net) plus marketable securities, divided by current liabilities. The "acid test" ratio is one of the most important credit barometers used by lending institutions, as it indicates the ability of a business enterprise to meet its current obligations.
Aging Receivables - A scheduling of accounts receivable according to the length of time they have been outstanding. This shows which accounts are not being paid in a timely manner and may reveal any difficulty in collecting long-overdue receivables. This may also be an important indicator of developing cash-flow problems.
Amortization - Liquidation on an installment basis; the process of gradually paying off a liability over a period of time (that is, a mortgage is amortized by periodically paying off part of the face amount of the mortgage).
Assets - The tangible resources, properties and property rights owned by an individual or business enterprise
Balance Sheet - An itemized statement that lists the total assets and the total liabilities of a given business to portray its net worth at a given moment in time
Breakeven Analysis - A method used to determine the point at which the business will neither make a profit nor incur a loss. That point is expressed in either the total dollars of revenue exactly offset by total expenses (fixed and variable); or in total units of production, the cost of which exactly equals the income derived by their sale.
Capital - Capital funds are those funds that are needed for the base of the business. Usually they are put into the business in a fairly permanent form such as in fixed assets, plant and equipment, or they are used in other ways which are not recoverable in the short run unless you sell the entire business.
Capital Equipment - Equipment that is used to manufacture a product, provide a service, or use to sell, store and deliver merchandise. Such equipment will not be sold in the normal course of business, but will be used and worn out or be consumed over time through the operation of the business.
Cash Flow - The actual movement of cash within a business: cash inflow minus cash outflow. A term used to designate the reported net income of a corporation plus amounts charged off for depreciation, depletion, amortization, and extraordinary charges to reserves, which are bookkeeping deductions and not actually paid out in cash. Offers a better indication of the ability of a firm to meet its own obligations and to pay dividends than with the conventional net income figure
Cash Position - See Liquidity
Construction Loans - These loans are like a line of credit crossed with a term loan: as construction of, say, a building, reaches certain stages, the bank disburses money that is repayable over a lengthy period of time, usually in a flat monthly payment, through sometimes in a balloon payment that must be refinanced.
Corporation - An artificial legal entity created by government grant and endowed with certain powers; a voluntary organization of persons, either actual individuals or legal entities, legally bound together to form a business enterprise.
Credit - Credit generally means trade credit unless stated otherwise, the accounts payable which suppliers and others may be willing to extend to a business. The credit terms are usually stated on the invoice as payment due within so many days, perhaps with a discount (reduced cost) available for early payment, and with added costs for paying later than the due date on the invoice. Trade credit is one of the major sources of financing for small businesses, and, for a stable small business, may be the major form of outside financing.
Current Assets - Cash or other items that will normally be turned into cash within one year and assets that will be used up in the operations of a firm within one year.
Current Liabilities - Amounts owed that will ordinarily be paid by a firm within one year. Such items include accounts payable, wages payable, taxes payable, the current portion of a long-term debt, and interest and dividends payable.
Current Ratio - Ratio of a firm's current assets to its current liabilities – the current ratio includes the value of inventories that have not yet been sold, so it is not the best evaluation of the current status of the firm. The "acid test" ratio, covering the most liquid of current assets, provides a better evaluation.
Deal - Refers to a proposal for financing business creation or expansion; a series of transactions and preparation of documents in order to obtain funds for business expansion or creation.
Debt - Debt refers to borrowed funds, whether from an individual's personal resources or from other individuals, banks, or other institutions. It is generally secured with a note, which in turn may be secured by a lien against property or other assets. Ordinarily, the note states repayment and interest provisions. These factors may vary greatly in both amount and duration depending upon the purpose, source and terms of the loan. Some debt is convertible; that is, it may be changed into direct ownership of a portion of a business under certain stated conditions.
Depreciation - A reduction in the value of fixed assets – the most important causes of depreciation are wear and tear, the effect of the elements, and gradual obsolescence that makes it unprofitable to continue using some assets until they have been exhausted. The purpose of the bookkeeping charge for depreciation is to write off the original cost of an asset (less expected salvage value) by equitably distributing charges against operations over the entire useful life of the asset.
Entrepreneur - Entrepreneur refers to an innovator of a business enterprise who recognizes opportunities to introduce a new product, a new production process, or an improved organization. An entrepreneur raises the necessary money, assembles the factors of production, organizes an operation to exploit the opportunity, and accepts the risk of potential failure of the venture.
Equity - Equity or net worth is the owner's investment in the business. Unlike capital, equity is what remains after the liabilities of the company are subtracted from the assets. Thus it may be greater than or less the capital invested in the business. Equity investment carries with it a share of ownership and usually a share in profits, as well as some say in how the business is managed. If you seek financing from outside investors, you may well find that the cost is parting with some equity; this sometimes is viewed as a threat to ownership even though effective control usually remains in the hands of the owner/manager.
Illiquid - See Liquidity
Limited Liability Company (LLC) - A limited liability company is a relatively new state-registered form of a business enterprise. For federal income tax purposes, it can be taxed as a proprietorship or partnership, but its members, like corporate shareholders, are not personally liable for the entity's debts and liabilities. Unlike a sub-chapter S corporation, there is no limit to the number of owners and different types of shareholders an LLC company may have.
Line of Credit - A source of funding that is either secured or unsecured; an agreement that ordinarily is renewed on an annual basis where a bank holds funds available for the use of a business. Usually an unsecured line will have to be completely paid out once a year. The advantage of a line of credit is that the money is there, ready to be used when needed, yet not costing more than a small fee until it is actually drawn upon. A credit card is a line of credit; it allows the individual to borrow up to a certain limit and make repayment in a pre-agreed fashion. No separate credit application is made at each use of the line. A line of credit is usually paid from normal operations; inventory is often seasonally financed under a line of credit, for example.
Liquidity - A term used to describe the solvency of a business, which has special reference to the degree of readiness in which assets can be converted into cash without a loss – also called cash position. If a firm's current assets cannot be converted into cash to meet current liabilities, the firm is said to be illiquid.
Loan Agreement - A loan agreement is a document that states repayment terms, interest rates, and usually, what a business can or cannot do as long as it owes money to (usually) a bank. A loan agreement may place restrictions on owner's salary, on dividends, on amount of other debt, on working capital levels, on sales, on number of added personnel, or whatever the lender views as a means of protection for the investment. It is helpful to note that while equity ordinarily controls a company, a loan agreement ensures that a large degree of control passes into the hands of the lender. This kind of agreement is frequently a condition of making a loan.
Loan - Debt money for small business is usually in the form of bank loans, loans that in a real sense are personal loans because a new small business is hard to evaluate in terms of creditworthiness and degree of risk, the two decisive variables in any judgment of making or not making a loan. A secured loan is a loan that is backed up by a claim against some asset or assets of a business; an unsecured loan is backed up by the faith the bank has in the borrower's ability to pay the money back. All loans fall into one of these categories. Note: The amount of collateral (assets securing the loan) asked for should always be considered – too much collateralization will restrict operational flexibility in the future. The purpose of collateral, incidentally, is to tie the individual to the deal, to make it hard to walk away if things get rough. Banks have no desire to become second-hand business-collateral dealers and even less desire to pull the personal assets of cosigners or co-makers. (Many bankers don't know this. They think, erroneously, that by securing the note with collateral they are making the loan "safer." They aren't.)
Long-Term Liabilities - Liabilities (expenses) that will not mature within the next twelve months
Market - The number of people and their total spending (actual or potential) for a product line or service within the geographic limits of the businesses' distribution capacity; market share is the percentage of the companies' sales compared to the sales of its competitors in total for a particular product or service
Note - The basic business loan – a note, represents a loan that will be repaid or substantially reduced thirty, sixty, or ninety days later at a stated interest rate. These are short-term, and unless they are made under a line of credit, a separate loan application is needed for each loan and each renewal.
Net Worth - The owner's equity in a given business represented by the excess of the total assets over the total amounts owing to outside creditors (total liabilities) at a given moment in time. Also, the net worth of an individual as determined by deduction the amount of all his or her personal liabilities from the total value of his or her personal assets.
Partnership - A legal relationship created by the voluntary association of two or more persons to carry on as co-owners of a business for profit; a type of business organization in which two or more persons agree on the amount of their contributions (capital and effort) and on the distribution of profits, if any.
Pro Forma - The Proforma is a projection or estimate of what may result in the future from actions in the present. A pro forma financial statement is one that shows how the actual operations of the business will turn out if certain assumptions are realized.
Profit - Profit is the excess of the selling price over all costs and expenses incurred in making the sale. Also, the reward to the entrepreneur for the risks assumed in the establishment, operation, and management of a given enterprise or undertaking.
Revolving Line of Credit - Similar to a line of credit, except it does not normally need to be paid out annually. This kind of loan is of particular interest to a rapidly growing company with weak capitalization and may be converted to a term loan under certain conditions. But its basic purpose is the same as a line of credit
Sole Proprietorship or Proprietorship - Refers to a type of business organization in which one individual owns the business. Legally, the owner is the business and personal assets are typically exposed to liabilities of the business.
Sub-Chapter S Corporation or Tax Option Corporation - A corporation that has selected under Sub-chapter S of the IRS Tax Code (by unanimous consent of its shareholders) not to pay any corporate tax on its income and, instead, to have the shareholders pay taxes on it, even though it may or may not be distributed. Shareholders of a tax option corporation are also entitled to deduct, on their individual returns, their shares of any net operating loss sustained by the corporation, subject to limitations in the tax code. In many respects, Sub-chapter S permits a corporation to behave for tax purposes, as a proprietorship or partnership.
Subordinated Debt - Subordinated debt is sometimes referred to as quasi-capital because it serves the same purposes as capital as far as a bank is concerned. Subordinating debt means placing that particular debt behind bank debt; that is, should the business fail and have to be sold for asset value, the bank gets paid before the holder of the subordinated debt. Often, the owners of a business will put loans made by them to the company in such a position which means that until the bank debt is paid off or reduced to a previously agreed amount, the owners cannot repay themselves.
Takeover - Takeover refers to the acquisition of one company by another company.
Target Market - The specific individuals, distinguished by socioeconomic, demographic, and/or interest characteristics, who are the most likely potential customers for the goods and/or services of a business.
Term Loan - Either secured or unsecured, usually for periods of more than a year to as many as twenty years; term loans are paid off like a mortgage; so many dollars per month for so many years. The most common uses of term loans are for equipment and other fixed asset purposes, for working capital, and for real estate. Ordinarily, businesses do not borrow for a year or less on a term basis; the cost to the bank would be excessive.
Working Capital - Working capital is the difference between current assets and current liabilities. Contrasted with capital, a permanent use of funds, working capital is for relatively short-term use. Working capital cycles through the business in a variety of forms: inventories, accounts and notes receivable, cash and securities, and prepaid expenses are but a few. Working capital shifts forms but remains an investment in and use of cash. Working capital may fluctuate in terms of seasonal needs. If a business has an inventory buildup prior to Christmas sales or the fall merchandising season, then the cash portion of working capital will be reduced; as the business sells off the inventory and retires payables, cash will increase. Due to this seasonal quality of working capital in some industries, it is wrong to rely too heavily on trade averages unless you know what point in the working capital cycle they come from.