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Finance Terms Made Simple

Written by: Jennifer Loftus

Article Overview: Do terms like "gross margin" and "deferral of taxes" scare you? If so, then this short reference guide is what you're looking for!

Finance Terms Made Simple

Human Resources may find itself at odds with Finance when seeking approval for proposals. While both hopefully have the organization's best interests in mind, different approaches and terminologies underscore the differences that often exist between these two departments. In this Astronology, we present a glossary of terms useful when seeking the buy-in of CFOs and Finance Departments.

ROI: Return on Investment. This refers to how much profit or cost saving is realized in a given period of time - usually a year - as the result of a particular expenditure. Human resources professionals who are sometimes accused of presenting "touchy-feely" rationales for monetary expenditures can use ROI calculations to help develop the financial case for a proposal in a way an organization's financial staff can readily understand.

While useful from an accounting point of view, the following five terms are also critical for designing and administering sales compensation plans:

Revenue: The total influx of funds into an organization, usually resulting from the sales of goods or services, calculated before costs or expenses are deducted. This figure includes all sales made to customers / clients in addition to other income arising from business operations.

Expenses: All costs deductible from revenues.

Gross Margin: Sales revenue minus the cost of the goods sold. This term is often used as a performance measure.

Net Income: Revenue minus expenses, including maintenance, taxes, and losses. This term is synonymous with the terms net earnings, net profit, and bottom line.

Profit Margin: The percentage of total revenues that net income represents. This term is often mistakenly used as a synonym for net income or profit. If total revenue for a given period is $12,000, and expenses are $10,000, the net income would be $2,000, while the profit margin would be 16.67%. Acceptable profit margins vary widely by industry.

Value Added: The sales price of goods or services minus the cost of any raw materials or inputs purchased elsewhere. Success is often measured by how much value an organization can add to its goods or services.

ROA: Return on assets; the ratio of net earnings to total assets. Sometimes used as a measurement in executive incentive compensation plans.

Asset: Anything owned by an organization or an individual with commercial or exchange value, including claims against others. Accounts receivable, product inventory, and buildings owned by the company are examples of assets. Often contrasted with liability.

Liability: Debt or responsibilities owed by an organization that must be paid in the future. Examples of liabilities are accounts payable, bonds payable, and taxes payable.

Deferral of Taxes: Postponement of taxes to a later payment period, often by recognizing income or gain at a later time, such as through qualified retirement plans.

Tax Incentives: Benefits that reduce pre-tax income, resulting in less tax paid by both employer and employee. New York City's TransitChek program is one example.

Earning Per Share: An organization's net income divided by total shares outstanding, adjusted for common stock equivalents. This is often used as the measurement in executive incentive compensation programs.

Balance Sheet: A detailed statement of an organization's finances, showing assets, liabilities, and net worth. The balance sheet follows the formula assets = liabilities + net worth. Net worth can be comprised of owner's equity and retained earnings. The balance sheet describes the financial well being of an organization on a given date.

Income Statement: A financial statement including revenues and expenses incurred during a particular period of time. The business equivalent of your personal checkbook.

Present Value: The current value of a cash payment, good, or service, discounted at an appropriate interest rate. By the logic of present value, $5 received five years from now is worth less than $5 received today. Using present-value formulae, assumptions about future interest rates are applied to produce estimates of the current worth of a dollar delivered at some specific point in the future. Such formulae are useful in determining ROI for proposed initiatives.

Days in Receivables: Average collection period, or how long it takes an organization to collect on invoices sent out for work performed / goods sold. The longer the average collection period, the greater the potential negative impact on cash flow.

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Article Tags: astronology, bottom line profit, business operations, cfos, compensation plans, finance departments, financial case, financial staff, glossary of terms, gross margin, human resources professionals, net profit, performance measure, profit margin, profit margins, rationales, roi calculations, roi return on investment, sales compensation, terminologies



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