Financial terms you should know – Part 5

1. Net Working Capital – Total of all current assets less total of all current liabilities.
2. Net Worth – Value of a firm’s to its owners (stockholders/shareholders) as shown on its balance sheet. It is the sum of the issued share capital, retained earnings, and capital gains. Also called net value.
3. Operating Statement – Detailed periodic report of the financial results of a firm’s operations, as compared with budgeted and previous period’s figures.
4. Overhead - Cost or expense (such as for administration, insurance, rent, and utility charges) that (1) relates to an operation or the firm as a whole, (2) does not become an integral part of a good or service (unlike raw material or direct labor), and (3) cannot be applied or traced to any specific unit of output. Overheads are indirect costs.
5. Preferred Stock – Class of stock (shares) that pays fixed and regular interest income, instead of a dividend (whose payment and amount depends on factors beyond stockholder’s control). Holders of preferred stock have claim over the firm’s earnings (and assets in case of liquidation) ahead of (senior to) the claim of holders of common stock (ordinary shares) but behind (junior to) the claims of bondholders and all other creditors. Depending on the terms of the agreement under which preferred stock is issued, the degree of control of its holders over the firm’s operations ranges from none to the same as that of the holders of common stock. Most preferred stock is cumulative; common stock holders cannot receive any dividend until all the unpaid interest owed to preferred stock holders is paid. For the issuing firm, preferred stock is an uneasy compromise between debt and equity, and is seen as capital with a tax advantage because interest is written off as expense against earnings. Also called preference shares.
6. Price/Earnings Ratio (P&E) - The most common measure of how expensive a stock is. The P/E ratio is equal to a stock’s market capitalization divided by its after-tax earnings over a 12-month period, usually the trailing period but occasionally the current or forward period. The value is the same whether the calculation is done for the whole company or on a per-share basis. For example, the P/E ratio of company A with a share price of $10 and earnings per share of $2 is 5. The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings. Companies with high P/E ratios are more likely to be considered “risky” investments than those with low P/E ratios, since a high P/E ratio signifies high expectations. Comparing P/E ratios is most valuable for companies within the same industry. The last year’s price/earnings ratio (P/E ratio) would be actual, while current year and forward year price/earnings ratio (P/E ratio) would be estimates, but in each case, the “P” in the equation is the current price. Companies that are not currently profitable (that is, ones which have negative earnings) don’t have a P/E ratio at all.
7. Prime Rate – The interest rate that commercial banks charge their most creditworthy borrowers, such as large corporations. The prime rate is a lagging indicator.
8. Retained Earnings - Earnings not paid out as dividends but instead reinvested in the core business or used to pay off debt. also called earned surplus or accumulated earnings or unappropriated profit.
9. Return on Equity – ROE. A measure of how well a company used reinvested earnings to generate additional earnings, equal to a fiscal year’s after-tax income (after preferred stock dividends but before common stock dividends) divided by book value, expressed as a percentage. It is used as a general indication of the company’s efficiency; in other words, how much profit it is able to generate given the resources provided by its stockholders. investors usually look for companies with returns on equity that are high and growing.
10. Return on Investment – ROI. A measure of a corporation’s profitability, equal to a fiscal year’s income divided by common stock and preferred stock equity plus long-term debt. ROI measures how effectively the firm uses its capital to generate profit; the higher the ROI, the better.
11. Return on Total Assets – ROTA. A measure of how effectively a company uses its assets. Calculated by (income before interest and tax) / (fixed assets + current assets).
12. Treasury Stock – Stock reacquired by a corporation to be retired or resold to the public. Treasury stock is issued but not outstanding, and is not taken into consideration when calculating earnings per share or dividends, or for voting purposes.
13. Working Capital – Current assets minus current liabilities. Working capital measures how much in liquid assets a company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations. Companies with negative working capital may lack the funds necessary for growth.
14. Working Capital Turnover – Ratio that shows the number of times the working capital is converted into revenue in an accounting period, or how efficient the management is in using its working capital to generate sales revenue. Formula: Sales revenue ÷ average working capital.

This concludes the five part series on Financial Terms You Should Know. Thanks for reading!