Business Jargon Buster

Shortly after John Richardson left the High Street Bank he worked for he took part in a European Social Fund project to mentor small businesses, specialising in finance.

In one of the businesses he was asked to mentor the owner said to him “When my accountant or Bank manager talks to me it is as if they are talking a foreign language. I want you to teach me that language”. From that meeting John developed a “jargon buster”. The definitions and explanations are not claimed to be original, indeed, to be of any use, they must reflect the consensus, and they are drawn from many sources including John’s own words.

 

They are divided into three sections:

• Terms that might be used when talking about your business’s Balance Sheet
• Terms that might be used when talking about your business’s Profit & Loss accounts
• Terms relating to borrowings and lending products

 

Balance Sheet Jargon

Capital

In a limited Company the nominal value of the issued share capital of the Company. In a Sole tradership and/or Partnership, the moneys invested by the proprietors together with any accumulated profits/losses.

Current Assets

Those assets of the business which will be quickly (That means less than 12 months) converted to cash. EG Debtors, Stock Raw Materials, VAT Refund, Short term investments.

Current Liabilities

Those liabilities which will be paid within 12 months, e.g. Trade Creditors, Bank overdraft, taxation, VAT, Capital repayments of long term loans due in the next 12 months etc .

Debtor Days

The average time it takes your debtors to pay what they owe you. Calculated by dividing Sales turnover for a period by the number of days in that period e.g. 365 for a full year.

Equity a.k.a shareholder funds

Equity is the total of Share capital issued, and all reserves both capital and revenue.

Fixed Assets

Assets of the business that are permanently used within the business such machinery, land and buildings etc.

Impersonal Ledger

A record containing details of all the organisations internal accounts i.e. those which do not refer to individuals/organisations with whom the organisation trades. Will contain individual ledgers for different classes of assets and liabilities, income, and /expenditure.
Logically there is also a Personal ledger but this usage is archaic, and refers to customer ledgers and Supplier ledgers.

Intangible Asset

An asset which while not existing in a material way still has a value. Examples include patents, copyright, goodwill etc.

Net Operating Asset a.k.a. capital employed

Refers to Share capital and reserves plus corporation Tax due and long term debts.

Sale & Leaseback

If you already own an asset, it is possible to raise finance on this asset through a sale and leaseback arrangement.
Whilst it is often thought of as only applying to land and buildings, it applies also to any other fixed asset which has an ascertainable value.
This method of finance has exactly the same underlying facility as finance or operating lease. The difference is that as you own the assets, you will be the supplier.
The invoice you raise will be for the lower of current market value or your tax written down value.

Shareholders Funds a.k.a. equity

Equity is the total of Share capital issued, and all reserves both capital and revenue.

Terms of Trade

This term describes the relationship between the credit an organisation gives to it’s customers and the credit it receives from it’s suppliers.
If the organisation gives longer credit to it’s customers than it receives from it’s suppliers it’s Terms of trade are said to be negative, if it is paid before it has to pay then it’s terms of trade are positive.
The impact of this relationship usually determines whether a profitable company needs to borrow from it’s bankers or whether it’s accounts run in the black.

Term Liabilities

Those liabilities which are not due to be paid within 12 months, e.g. HP, Bank Loans.
Capital repayments of long term loans due in the next 12 months etc are included within Current liabilities.

 

Profit & Loss Account Jargon

Amoertisation

An accounting term relating to deduction from net profit for the estimated loss of monetary value of an Intangible Asset owing to time, or obsolescence.

Breakeven

The point where the Contribution (see further down) from the various constituent parts of the business equal the Indirect Costs.
Can be quickly ascertained by Dividing the Indirect costs by the Gross Profit PERCENTAGE, either historical or forecast.

Capital Allowances

The amount of depreciation or amortisation allowed by the Inland Revenue to be offset against Profit for Corporation Tax purposes.
Depending on the then current rules, this may be less or greater than the accounting depreciation/amortisation for the same period.

Contribution

Used when analysing the impact of a particular sales line(s) to the business the gross profit resulting from taking the sales income for that line less its particular direct costs. Derives from usage of “Contribution towards Overheads.

Cost of Goods Sold 'COGS'

The total value of Opening stock less closing stock plus purchases of raw materials and goods for resale are referred to as 'the cost of goods sold' COGS

Depreciation

An accounting term relating to deduction from net profit for the estimated loss of monetary value of a Fixed Asset owing to usage, time, obsolescence.
Similar to Amortisation, but usually only used in relation to a Fixed Asset.

Direct Costs

Expenses directly incurred in buying in goods to sell or raw materials. In a manufacturing business production expenses including production wages are often included. Theoretically these expenses will vary in exact proportion to sales.

Gross Margin (agriculture)

The gross Margin of enterprise is its enterprise output less its variable costs. Enterprise output includes the market value of production retained on the farm. The variable costs must be :-
a. specific to the enterprise
b. vary in proportion to the size of the enterprise.
The enterprise is the production of a particular crop i.e. Winter wheat or Malting Barley

Gross Profit

The amount of profit remaining when Direct Costs are deducted from sales income.

Indirect Costs a.k.a. overheads or fixed costs

All expenses incurred by the business which are not directly related to the production of items sold or remain the same no matter how sales vary. E.g. Rent, insurance, office salaries etc.

Net Profit a.k.a. profit before tax (PBT)

Gross profit less Indirect costs less Interest payable and extraordinary items.

Net Profit Margin

% Net profit margin (Net profit. margin) is net income before taxes divided by net sales.
Computed as the net profit on sales and presents it as a percentage.

Operating Expenses / Sales

The Operating Expenses to Sales ratio is calculated as the Total Operating Expense (Including Drawings where appropriate) on the Profit and Loss Account (which includes applicable depreciation expenses) divided by Net Sales and expressed as a percentage.

Operating Expenses

Indirect Costs less Interest paid and received and extraordinary Items.

Operating Margin

The Operating Margin is calculated as the Operating Profit (the Gross Profit less Operating Expenses (Including Drawings where appropriate)) divided by Net Sales. It is expressed as a percentage.
Operating expenses do not include Interest expense, Other Income/Expense or the Gain or Loss on asset sales.
The Operating Margin is a traditional measure of the Debtor's operating efficiency.

Overheads

All expenses incurred by the business which are not directly related to the production of items sold or remain the same no matter how sales vary. E.g. Rent, insurance, office salaries etc.

Profit Before Tax (PBT) a.k.a. net profit

Gross profit less Indirect costs less Interest payable and extraordinary items.

Variable Costs a.k.a direct costs

Expenses directly incurred in buying in goods to sell or raw materials. In a manufacturing business production expenses including production wages are often included.
Theoretically these expenses will vary in exact proportion to sales.

 

Lending Jargon

Chattel Mortgage

A Chattel Mortgage is a fixed charge over an asset other than freehold land.
The finance company will then advance money against the security of these chattels. Their charge will be registered, but you will not need to invoice the funder for the assets.
This is particularly useful if the assets have a low tax written down value or if you have concerns about posting a profit/loss on disposal.

Having said that Chattel Mortgages are generally only available for corporate bodies to which English Law applies (Scottish Law does not recognise a Chattel Mortgages).

Documentary Credit a.k.a. letter of credit

A method of payment for goods in which the buyer establishes his credit with a local bank, clearly describing the goods to be purchased, the price, the documentation required, and a time limit for completion of the transaction.
On presentation of the requested documentation funds are released to the supplier.
Unless you specify that quality certification is required there are no guarantees that the goods themselves are of the required standard.

Factoring

This is the purchase of debts owed, or "accounts receivable," in exchange for immediate payment at a discount. The factor takes on responsibility for the management of the accounts receivable. The Factor charges comprise two different types of cost. “discount” the interest charged on moneys drawn down. Service Charge – this is normally a percentage of turnover and reflects the work the factor does in running the Accounts receivable ledger.
Factoring is always disclosed to your customer as they need to make payments direct to the Factor.

Finance Lease

With any finance lease contract the finance company takes full ownership of the asset and rents the goods to you over a predetermined period. The finance company can claim the writing down allowances and convey this benefit to you by reducing the rentals.
It also worth noting that the purchase price that is being used to calculate the rental is the purchase price net of VAT. Thus, if you are looking to acquire a VAT qualifying car, if

leased the rental is calculated on the net price of the car and not the gross price if funded by Hire Purchase. Generally, with a finance lease, you will source the supplier, and having paid the documentation fee and an initial payment of a multiple of rentals, substantially all of the remaining cost of the asset is spread over the agreed primary period in accordance with the pause.
The rentals attract VAT that can be recovered subject to eligibility. As the finance company is the owner of the asset, you will not need to pay the purchase VAT at inception.
As with Hire Purchase, you can include a balloon rental to reduce the value of the primary rentals. At the end of the agreement you may have the option to enter into the secondary period. As you have generally covered the entire capital cost of the asset and hire charges (interest) in the primary period, should you wish to continue to use the asset, a secondary or peppercorn rental is charged. This rental typically approximates to 3% of the original cost and is a one off annual payment. As you are not the owner of the asset, you cannot sell the asset during the rental period. However, as you are generally covering the total cost and hire charges within the primary period, you will be entitled to a share of the sale proceeds should the leasing company allow you to sell on their behalf. Your share of the sale proceeds is usually agreed at inception and is typically 95-99%.

Forward Exchange Contract

A contract entered into with a Bank to buy or sell Foreign exchange at a time in the future at a fixed rate.
As rates are based on differentials in current interest rates the rate quoted should not be taken as indicative of expectations that that exchange rate is likely to be the exchange rate at the time the transaction is completed.
Most Financial Institutions do not charge for entering into a Forward Contract but as there is Credit Risk involved for them they may require some form of Margin Deposit or security.

Hire Purchase

This is the most typical and readily available credit facility. In basic terms, you source the asset and negotiate the purchase price with the supplier.
You pay a deposit to the finance company, typically 10-20%, and the finance company then takes title direct from the supplier.

Even though you are technically not the owner of the asset during the agreement, subject to eligibility you can still claim the writing down allowances as though you had made the purchase outright.
At inception you would usually be required to pay a documentation (or administration, arrangement) fee and the full purchase VAT. You will then, subject to eligibility, recover the VAT yourself. You repay the outstanding amount and interest in pre-agreed instalments over the period of the agreement.

Invoice Discounting

Similar to Factoring, the crucial differences are that:
1. The arrangement is not always disclosed to the organisations which owe the money to your business.
2. Management of the Sales ledger remains in your hands.

Lease Purchase

This is practically identical to Hire Purchase, the only difference being that instead of paying a deposit of 10-15% you typically pay a deposit as a multiple of the repayments. The remaining balance and interest is repaid in instalments. The number of instalments is defined by the pause.
As an example, a hire purchase agreement would have a 10% deposit followed by 36 monthly repayments. The equivalent Lease Purchase would have a profile of 3 payments in advance followed by 33 (if terminal pause) or 35 (if spread pause) monthly repayments.
Your eligibility for the VAT and writing down allowances is exactly the same as for hire purchase, and you can expect the fee structure to be the same.

Letter of Credit a.k.a. documentary credit

A method of payment for goods in which the buyer establishes his credit with a local bank, clearly describing the goods to be purchased, the price, the documentation required, and a time limit for completion of the transaction.
On presentation of the requested documentation funds are released to the supplier.
Unless you specify that quality certification is required there are no guarantees that the goods themselves are of the required standard.

Operating Lease

The only difference between an operating lease and a Finance Lease is that the primary period rentals do not cover substantially all of the capital cost and hire charges. For example a lease for a printing press costing £400,000 may include a residual value at the end of the primary period of £150,000. The primary rentals are thus based on £250,000 and not the capital cost of £400,000.
Due to the fact that the asset needs to be sold on at the end of the primary period to recover the residual value, it is very rare for an operating lease to have a secondary rental period. In some instances the funder may structure a finance lease for you to 'wash-out' the residual position.
With an Operating Lease you may source the supplier, but it is often the case that the leasing company can acquire the asset for you cheaper (for example car leasing companies). You will have to pay any documentation fee and an initial payment of a multiple of rentals. The rentals attract VAT that can be recovered subject to eligibility. As the finance company is the owner of the asset, you will not need to pay the purchase VAT at inception.

Spot Rate

The rate at which two currencies are traded at now. Custom and practice is that if you buy at “Spot” delivery of the Currency takes place two working days later.

Term Loan

A loan granted for where repayment is for a period of more than 12 months.

Trade Creditors

Moneys owed by the business in respect of goods and services received.

Trade Debtors

Moneys owed to the business in respect of goods or services supplied.

Working Capital

Strictly it means the difference between Current assets and Current Liabilities (and should be positive!)
However Common usage now refers to Cash plus any short term borrowing facility (i.e. Overdraft, Invoice discounting etc) available to business.

 

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