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Thomson Nelson > Higher Education > Practical Financial Management, First Canadian Edition> Student Resources > Glossary

Glossary

A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

(Numbers in parentheses refer to the chapter(s) containing the main discussion of the term.)

A

ABC system
A system of controlling inventory that recognizes the differing cost and importance of various items. A parts are expensive and/or important and are controlled carefully. C parts are cheap and plentiful, so little effort is expended to monitor them. B parts are between As and Cs. (4)

Accelerated amortization
See amortization. (2)

Accounting period
In business, time is divided into accounting periods—usually months, quarters, and years—during which the accounting system accumulates transactions and produces financial reports. Also see financial statements. (2)

Accounting system
Generates the data on costs, earnings, and financial position required for making financial decisions. (2)

Accrual
An accrual is an accounting entry used to recognize expenses and liabilities associated with transactions that are not entirely complete, for example, a payroll accrual for unpaid wages. (2)

Accumulated amortization
The sum of all amortization written off to date. Carried as an offset to the value of a capital asset, so at any time the net book value of the asset is the difference between its original cost and its accumulated amortization. Also see amortization. (2)

Acquisition
A merger in which one company acquires the shares of another. May be friendly or hostile (unfriendly). See merger. (19)

After-tax income
The income remaining to the recipient after taxes have been paid. The most relevant income for judging business results and investment returns. (2)

Agency
A relationship between two parties in which one (the principal) employs the other (the agent) in a decision-making capacity. (1)

Agency problem
In corporations, managers are the agents of shareholders and are often able to take advantage of the relationship by diverting corporate resources to their own use. Excessive pay is the primary example. The general situation is described as the agency problem. Costs associated with controlling the agency problem are agency costs. (1)

Amortization
The accounting entry allocating the cost of a capital asset against income over the asset’s life. Amortization methods include straight-line and accelerated amortization. Straight-line amortization is evenly prorated. Accelerated amortization is any method that shifts amortization forward in an asset’s life. Accelerated methods increase early charges and reduce those that come later, keeping total amortization constant. Capital cost allowance, used for tax purposes, is a type of accelerated amortization. Amortization is a noncash charge, so net income is generally less than true cash flow by at least the amount of amortization. Also see accumulated amortization, capital cost allowance. (2)

Amortized debt
A debt in which the principal is repaid over the life of the loan rather than in a lump sum at the end. (8)

Annual percentage rate (APR)
See nominal interest rate. (8)

Annual report
A yearly report on a company’s performance prepared by management. An annual report includes financial statements and generally contains verbal discussions of the firm’s operations and prospects. (3)

Annuity
A finite series of equal payments at equal intervals of time. In an ordinary annuity, the payments occur at the end of the time periods. In an annuity due, they occur at the beginning. (8)

Annuity due
See annuity. (8)

Asset management (turnover) ratios
Financial ratios that measure the firm’s ability to generate revenue using its assets. Examples include inventory turnover, capital asset turnover, and total asset turnover. Also see ratio analysis. (3)

Average collection period (ACP)
A financial ratio that measures how long it takes to collect on credit sales. Also called days sales outstanding (DSO). ACP is an indicator of the collectibility of the receivables and the efficiency
of the credit and collection system. The closer the ACP to the firm’s credit terms, the better. (3)

Average tax rate
See tax rates. (2)

B

Backorder
In inventory management, an order for an out-of-stock item, usually on an expedited basis. (4)

Balance sheet
Financial statement as of a moment in time. It says that, at the end of the accounting period, the company owns a particular list of assets and owes a particular list of creditors, the difference representing the book value of the owners’ interest. (2)

Bankers’ acceptance (BA)
A promissory note or draft of a corporate borrower with a guarantee of payment by a chartered bank. Often sold in the money market. Also see money market. (5)

Bankruptcy
A federal court procedure to protect a failing firm from its creditors until the best solution to its problems can be found. Also see insolvency. (19)

Base rate
The rate at which people lend money when there’s no risk involved in the loan. It has two components: the pure interest rate (also known as the earning power of money), and the expected rate of inflation over the life of the loan. (7)

Basic EPS
Earnings after tax divided by the weighted average number of shares outstanding during the year. (18)

Bearer bond
An unregistered bond, owned by the “bearer,” the person in possession. Contrast with registered securities. (9)

Benchmarking
A type of analysis in which a company compares its ratio values with those of a key competitor or group of competitors, primarily to identify areas for improvement. (3)

Beta
The measure of market risk in portfolio theory. The degree to which a stock’s return moves with the market’s return. (11)

Black–Scholes option pricing model
A viable option pricing model, developed by financial scholars Fisher Black and Myron Scholes, that gives results similar to those of stock pricing models. (18)

Blanket inventory lien
In finance, gives the lender in an inventory loan a lien against all inventories held by the borrower. The borrower remains in complete physical control of the inventory, but commits to use the proceeds on sale to pay off the loan. Compare with trust receipt. (5)

Board of directors
The governing body of a corporation, elected by common shareholders. (10)

Bond
A security reflecting a relatively long-term debt relationship between the issuer (borrower) and the buyer (investor/lender). (1)

Bond rating
A measure of the likelihood of default on payment of interest or principal. Ratings are prepared by rating agencies. Dominion Bond Rating Service (DBRS) and Standard and Poor’s are two Canadian bond rating agencies. (9)

Book value
For a company, the value of equity, equal to total assets minus total liabilities. Book value can be stated in total or per share. For an asset, book value is the net of original cost minus accumulated amortization, and is generally referred to as net book value. (3)

Bottom-up planning
Business planning based on inputs from lower-level management. The process tends to understate achievable performance because people set easily achievable goals for themselves. Contrast with top-down planning. (6)

Breakeven analysis
A technique for finding the volume at which a firm breaks even financially—that is, earns zero profit. (16)

Broker
See stockbroker. (1)

Brokerage firm (house)
A company of stockbrokers generally having the right to trade on an exchange. (7)

Budget
A short-term, financially detailed business plan, usually covering about a calendar quarter. (6)

Business plan
A document projecting a firm’s physical and financial performance into the future. Business plans can be short- or long-range. Long-range plans are “strategic” and tend to be more verbal than financial. Shorter-term plans are described as “operational,” and detail the more routine running of the business. (6)

Business risk
Variation in a company’s financial performance caused by changes in business conditions. (16)

Business-specific risk
Variation in the return on a share investment caused by things that affect specific businesses or industries. Contrast with market risk. (11)

C

Call (option)
The right to purchase a share at a specified price over a designated period of time. See option. Compare with put option. (18)

Call provision (feature)
A provision in a bond contract that allows the borrowing organization to “call” in the bond and pay it off early. Calls are generally exercised when interest rates have dropped substantially since the bond’s issue. An additional payment known as the call premium must usually be made to the investor if the call is exercised. Most call features cannot be exercised during an initial call-protected period. (9)

Canadian controlled private
corporation (CCPC)

In the Tax Act, a relatively small, closely held private corporation with less than 100 employees and a small market share. It is allowed relatively low rates of tax. (2)

Capital
Long-term assets or the money used to support long-term assets and projects. Long-term debt and equity on the balance sheet. Also see capital asset. (2)

Capital asset
A real or tangible asset that is acquired for long-term use in the business. Capital assets include property, plant and equipment. (2)

Capital asset pricing model (CAPM)
A statistical model of the investment world aimed at explaining how required returns are determined in financial markets and thereby how share prices are set. Also see security market line. (11)

Capital asset turnover
A financial ratio measuring the relationship of the firm’s capital assets to the year’s sales. Defined as Sales ÷ Capital assets. (3)

Capital budgeting
Analysis techniques concerned with justifying money spent on long-term assets and projects. Projects may be expansions, replacements, or new ventures. (12)

Capital component
One of three sources of capital: long-term debt, preferred shares or equity. (15)

Capital cost allowance (CCA)
The system of amortization prescribed for tax computations, usually on a declining balance (acclerated) basis. Classes and maximum amortization rates are set for various types of capital assets. For example, computer equipment is Class 10, and the maximum CCA rate is 30% per year, applied to the balance remaining (Undepreciated Capital Cost) in the class. Also see undepreciated capital cost. (13)

Capital gain (loss)
The difference between the sale and purchase price of an investment or capital asset held over a period of time. Also see taxable capital gain. (2)

Capital gain yield
The capital gain on a share divided by the price at which it was purchased. (10)

Capital lease
See financing lease. (9)

Capital market
A financial market in which longer-term (at least one year) debt and shares are traded. (7)

Capital rationing
In capital budgeting, the process of allocating available capital among projects to maximize total NPV. (12)

Capital restructuring
Changing a firm’s capital structure intentionally by buying and selling stocks and bonds simultaneously. (16)

Capital structure
The mix of the three capital components (debt, preferred shares, and equity) used by a firm. The optimal capital structure is the structure at which share price is maximized, all other things held equal. Also see target capital structure. (15)

Cash conversion cycle
The time from the disbursement of cash to pay for inventory to the receipt of cash for product sold. The cash conversion cycle is shorter than the operating cycle by the period during which the firm holds a payable for the inventory. Compare with operating cycle. (4)

Cash discount
A reduction in the amount owed by a buyer in exchange for prompt payment of the supplier’s invoice. (5)

Cash forecast (budget)
A forecast of cash flows based on expected receipts and disbursements rather than on projections of income statement and balance sheet accounts. (6)

CCA tax shield
The tax savings that the firm will experience from being able to claim CCA on its capital assets. (13)

Cheque clearing process
The routine procedure through which one party pays another with a cheque through the banking system. (4)

Chief financial officer (CFO)
The executive in charge of the financial function. (1)

Clean-up requirement
The requirement that borrowers pay off all short-term debt for some period each year. Prevents funding long-term projects with short-term debt. (5)

Clientele effect
The theory that firms attract equity investors at least in part because of their dividend-paying policies. The firm has a “clientele” of shareholders whose need for current or deferred income matches the firm’s dividend practices. The implication is that it isn’t a good idea to change dividend policies because such a change is bound to displease most shareholders. (17)

Closing price
The price of a security in the last trade of a business day. (7)

Collateral
An asset backing a loan. In the event of default the collateral becomes the property of the lender to satisfy the obligation. Also called security for the loan. Also see blanket inventory lien, trust receipt, pledging receivables. (1)

Collection agency
A firm that specializes in collecting debts, especially overdue receivables, for a percentage of the amount collected. (4)

Collections policy
The manner and aggressiveness with which a firm pursues payment from delinquent customers. (4)

Commercial paper
Very short-term debt issued by major companies. Sold at a discount. (5)

Commitment fee
Also called a standby fee, this is a fee charged by a bank for guaranteeing to have loanable funds available. The fee is charged on unborrowed amounts up to the maximum of the guarantee. See revolving credit agreement. (5)

Common size statement
A firm’s income statement with every line stated as a percent of revenue. A balance sheet with every line stated as a percent of total assets. Used to compare companies of different sizes or to identify performance trends in a single company over time. (3)

Common share or common stock
The security representing ownership of a corporation. Partion of shareholders’ equity. (10)

Competition Act
A body of legislation aimed at maintaining the competitive nature of the economy. The Act can prohibit certain mergers on the basis that they reduce competition. (19)

Compounding period
The period of time after which interest is credited to the depositor’s account for purposes of computing subsequent interest. (8)

Compound interest
The concept of earning interest on previously earned interest. A sum earning compound interest grows exponentially over time. (8)

Concentration banking
Employing one centralized bank account to manage the balances in remote accounts. Balances are generally transferred electronically into the concentration bank daily. (4)

Conglomerate merger
A merger between companies in unrelated businesses. (19)

Consolidation
A combination of two or more businesses in which all of the old legal entities dissolve and a new one with a new name is formed to continue into the future. (19)

Contribution (margin)
In breakeven analysis, contribution is the difference between price and variable cost that is “contributed” toward profit and fixed costs. The contribution margin is the contribution expressed as a percent of price. (16)

Controller
The executive in charge of the accounting function in most companies. The controller generally reports to the CFO in large companies. (1)

Conversion price
Stating the conversion ratio along with the bond’s par value. Also see conversion ratio. (18)

Conversion ratio
A ratio set at the time bonds are issued; determines the number of shares that can be exchanged for a bond. (18)

Convertible bond
A bond that can be converted into a specified number of shares at the owner’s discretion. (9)

Convertible currency
A currency that can be exchanged for other currencies on foreign exchange markets. Contrast with inconvertible currency. (20)

Corporate restructuring
A broad term describing a number of ways in which companies are reorganized. Includes capital restructure, mergers, and reorganizations in bankruptcy as well as changes in certain methods of doing business. (19)

Corporation
A form of business organization in which the business is a separate legal entity subject to a corporate tax on whatever it earns. (1)

Corporation tax
A tax levied by the federal and provincial governments on a corporation, which is a taxpayer separate from its shareholders. (2)

Cost of capital
The average rate a firm pays its investors for the use of their funds, adjusted for taxes and administrative costs. Also called the WACC for weighted average cost of capital. Developed from the costs of individual capital components that are the rates, adjusted for taxes and flotation costs, that are paid on debt, preferred shares, and common equity. The component costs are (weighted) averaged to get the WACC. (12)

Cost of goods sold
Spending closely associated with production or purchase of the products for sale. Contrast with expenses. (2)

Cost structure
The mix of fixed and variable cost used by a firm. (16)

Coupon rate, coupon payment
The interest rate paid by a bond on its face value. The dollar amount of the interest payment, which is usually made semiannually. (9)

Credit agency (bureau)
An organization that maintains records of the bill-paying histories of most companies and assigns credit ratings to firms that indicate how well they’ve paid their bills in the past. The agency’s subscribers can receive credit reports on companies with which they’re considering doing business. (4)

Creditor
Anyone owed money by a business, including lenders, vendors, employees, or the government. (1)

Credit policy
A business’s guidelines for identifying the customers to whom it is willing to sell on credit, and the level of credit to be allowed. It is a statement of the minimum customer quality the business will accept for credit sales. (4)

Cross rate
In foreign exchange markets, an exchange rate between any two currencies developed without going through dollars. (20)

Cumulative feature of preferred shares
A provision to enhance the safety of preferred shares. If preferred dividends are passed, no common dividends can be paid until preferred dividends are caught up cumulatively. (10)

Cumulative voting
A method of electing boards of directors in which shareholders can cast all of their votes for a single seat. Enables minority interests to get at least some representation on the board. (10)

Current assets
Assets expected to become cash in less than one year. Current assets are largely cash, receivables, and inventories. (2)

Current liabilities
Obligations expected to require cash in less than one year; usually payables and accruals. (2)

Current ratio
Current assets divided by current liabilities. A financial ratio that measures a firm’s liquidity, the ability to pay its bills in the short run. (3)

Current yield
A bond’s annual interest payment divided by its market price. (9)

D

Date of record
When a dividend is declared, it is paid to owners of record on the transfer agent’s books as of the date of record. Also see (dividend) declaration date. (17)

Debenture
An unsecured bond. (9)

Debt management ratios
Financial ratios that measure the financial risk the firm has assumed by borrowing. Examples include debt ratio, debt to equity ratio, times interest earned, cash coverage, and fixed charge coverage. Also see ratio analysis. (3)

Debt ratio
Total liabilities divided by total assets. A financial ratio measuring the degree to which the firm uses borrowed money to finance its operations. (3)

Debt to equity ratio
A financial ratio measuring the relative amounts of long-term debt and equity in a firm’s capital structure. (3)

Decision tree
A timeline representation used in planning projects subject to multiple outcomes. Wherever an event has several outcomes, the timeline branches into as many paths, each with a probability. The result is a proliferation of possible paths to completion, each representing an outcome, its financial implication, and its probability. Hence, the decision tree specifies a probability distribution for the project’s overall financial outcome. (14)

Declaration date
The date on which a firm’s board of directors declares a dividend. (17)

Deductions
Items of expenditure that the Tax Act allows taxpayers to deduct from income to arrive at taxable income. (2)

Default risk
The risk of loss to a lender from the borrower’s failure to pay the full amount due including interest and principal. (7)

Defensive tactics
Actions taken by the management of a company to resist or avoid being acquired. (19)

Derivative security
A security whose price is derived from the price of another security. The most common example is an option to buy or sell shares. The value of the option is related to the price of the shares being bought or sold. See option. (18)

Devaluation
In foreign exchange markets, a significant decrease in the value of a currency compared to major currencies, such as the U.S. dollar. A financial or monetary crisis is often the incentive for a government to officially lower the value of its currency relative to the U.S. dollar. (20)

Diluted EPS
Earnings per share reflecting the hypothetical conversion or exercise of all convertibles, warrants, and options outstanding. (18)

Dilution
The reduction in earnings per share (EPS) and book value per share that results from the conversion of convertible securities or the exercise of warrants or employee stock options. Fully diluted values for earnings per share and book value per share reflect the hypothetical conversion or exercise of all convertibles, warrants, and options outstanding. Also see EPS, book value. (18)

Discount
Generally a reduction in price or value. In finance, a reduction in the present value of a future sum due to effect of compound interest. Also see discounted cash flow. (8)

Discounted cash flow
Calculations involving the present and future values of money under the action of compound interest. Also called the time value of money. (8)

Diversification
In finance, selecting a portfolio of different (diverse) investments to limit the overall risk borne by the investor. (11)

Divestiture
Getting rid of a business unit. The reverse of an acquisition. (19)

Dividend
The payment made by a corporation to an equity investor (shareholder). (10)

Dividend aversion theory
A logical argument that shareholders should be averse to the payment of dividends. (17)

Dividend decision
The decision by management regarding the portion of earnings paid to shareholders as dividends. The alternative is to retain the money, investing it in the company for future growth. (17)

Dividend irrelevance theory
A logical argument that shareholders should be indifferent to the payment of dividends. (17)

Dividend payout ratio
Dividend per share over earnings per share. A firm may select a target payout ratio to satisfy shareholders while retaining funds for business needs. (17)

Dividend policy
The rationale under which a firm determines what it will pay in dividends, both in amount paid and the pattern under which changes in the amount occur over time. Also see dividend decision.(17)

Dividend preference theory
A logical argument that shareholders should prefer the payment of dividends. (17)

Dividend tax credit
The tax credit allowed to shareholders to compensate for the corporation tax already paid. The dividend tax credit reduces the effective amount of personal tax on the dividend. (2)

Dividend reinvestment plan (DRIP)
An optional plan offered to shareholders under which the company keeps the dividends of participating shareholders and gives them additional shares instead. (17)

Dividend yield
A share’s annual dividend divided by its current price. (7)

Double taxation of corporate earnings
The primary financial disadvantage of the corporate form. A corporation’s earnings are subject to corporate tax when earned and personal tax when paid to shareholders as dividends. The dividend tax credit serves to compensate the shareholder for the fact that their dividend has been reduced because of corporate tax paid. Also see dividend tax credit. In foreign direct investment, double taxation is a situation where the income of the foreign affiliate is taxed in the foreign country and in Canada. Tax treaties and foreign tax credits may reduce or eliminate this form of double taxation. (1)

Dunning
Pursuing a customer for payment of an overdue receivable. (4)

Du Pont equations
A series of relationships between financial ratios that illustrates the inner workings of businesses and how performance in one area influences performance in others, and ultimately ROE (return on equity). (3)

E

Earnings after taxes (EAT)
A measure of a firm’s profitability. Also called net income or “the bottom line.”

Earnings before interest and taxes (EBIT)
A measure of a firm’s performance without regard to how it is financed. Also called operating income or operating profit. (2)

Earnings dilution
A drop in EPS caused by a sale of shares at a below-market price. (18)

Earnings per share (EPS)
A firm’s earnings stated on a per-share outstanding basis. An important measure of business performance in the stock market. (3) Basic EPS: Earnings after tax divided by the weighted average number of shares outstanding during the year. (18) Diluted EPS: Assumes all convertibles, warrants or options are exercised as of the beginning of the year. (18)

Economic order quantity (EOQ) model
A technique for minimizing the sum of inventory ordering and carrying costs. Also see inventory ordering costs and inventory carrying costs. (4)

Economic risk
In foreign direct investment, refers to the potential long-run impact of exchange rate fluctuations on the value of a foreign affiliate. In particular, if the local exchange rate declines steadily over time, the affiliate (and its parent) may suffer financial loss. (20)

Economic value added (EVA)
A measure of income that recognizes the cost of equity as well as debt. A positive EVA represents a contribution to shareholder wealth over that required by an equity investor, and is viewed as an increment to market value added (MVA). EVA is after-tax EBIT less the product of capital and the cost of capital. Also see market value added. (3)

Effective annual rate (EAR)
The annually compounded rate that pays the same interest as a lower rate compounded more frequently. (8)

Efficient market hypothesis
The assertion that information travels around the financial system so fast that share prices virtually always reflect all available information. The concept implies that technical analysis is useless. (10)

Electronic funds transfer (EFT)
A system in which funds are moved between computers without the use of a cheque; for example, they are moved through the use of a debit card and the Interac system. (4)

EPS
See earnings per share. (3)

Equivalent annual annuity (EAA) method.
In capital budgeting, a method for dealing with projects with unequal lives. The EAA method converts the net present value of each project into an equivalent annual amount (in NPV terms). This amount can then be used to select the better project. Also see net present value. (12)

Equity
An ownership interest. The portion of a firm’s capital representing funds belonging to its shareholders. An equity investment is an investment in share. (1)

Equity multiplier
Total assets divided by equity. A financial ratio in the Du Pont equations measuring the effect on return on equity from the use of debt. Also see Du Pont equations (3)

Euro
A common European currency adopted in January 2002 by 12 of the members of the European Union. (20)

Eurobond
A bond denominated in a currency other than that of the country in which it is sold and issued by a foreign borrower. Contrast with foreign bond. (20)

Eurocurrency loans
Large short-term or medium-term loans denominated in foreign currencies and available from foreign banks. Eurocurrency loans allow large Canadian companies to access capital markets outside of Canada when interest rates in Canada are elevated. (20)

Eurodollars
U.S. dollars deposited in banks in other countries and available for eurodollar (eurocurrency) loans. Also see eurocurrency loans. (20)

Exchange
In capital markets, a company that provides a physical or electronic marketplace and the administrative capability of transferring shares from one owner to another. (7)

Exchange rate
In international business, the rate at which one currency can be traded for another. Spot rates are available for current trades. Forward rates are available for currency to be delivered in a specified period of time. (20)

Exchange rate risk (exposure)
The risk that international trade dealings will earn more or less than expected because of movement in exchange rates before the transaction is completed. Also called transaction risk. (20)

Ex-dividend date
The date on which a share trades without a declared dividend that has yet to be paid. Two days prior to the date of record. Also see declaration date, payment date, date of record. (17)

Exercise price
See strike price. (18)

Expectations theory (with respect to dividends)
A dividend that’s lower than expected will be taken as a negative by investors even if it is larger than previous dividends. A variation on the signalling effect of dividends. (17)

Expectations theory (with respect to interest rates)
A theory explaining the shape of the interest yield curve. The curve slopes upward or downward depending on whether expectations about future interest and inflation rates are increasing or decreasing. (7)

Expected return
The return an investor believes is most likely on an investment—that is, the investor understands that the actual return may be somewhat different in certain investments like shares. The mean of the probability distribution of returns. (11)

Expense
An item of expenditure not closely related to production. Contrast with cost. (2)

Expropriate
In foreign direct investments, the seizure of assets held in a foreign country by the government of that country. Also see political risk. (20)

External funding requirement
Defined as (Growth in assets) – (Growth in current liabilities) – (Earnings retained). Provides an estimate of funding needs assuming all financial items vary directly with sales. (6)

F

Factoring receivables
Selling receivables to a financing source for an amount less than their face value. (5)

Finance
(noun) The art and science of handling money. (1)

Finance
(verb) To raise money to acquire an asset to do some project. (1)

Financial analyst
A person who studies the financial results of businesses and makes recommendations on their values as investments. (1, 3)

Financial assets
Shares and bonds. More generally a document giving its owner a claim to certain future cash flows. Shares base that claim on ownership (equity), while bonds base it on debt. Also called a security. (1)

Financial books
The regular statements of the company, not to satisfy the tax rules. They differ from the tax books primarily in the area of amortization. Contrast with tax books. (2)

Financial economics
A somewhat archaic term for financial theory emphasizing the field’s roots in economics. (1)

Financial information
The results of business operations stated in money terms; the material in financial statements, but not entirely limited to those documents. (3)

Financial instrument
A security or financial asset. (1)

Financial intermediary
An institution that sells shares in itself and invests the funds collected on behalf of its investors. Mutual funds are the primary example. (7)

Financial leverage
The use of borrowed money to multiply financial performance in terms of ROE and EPS. (2)

Financial markets
Markets in which financial assets are traded—for example, the stock market. (1, 7)

Financial plan
A projection of a company’s financial statements into the future based on a series of assumptions about what the business and the environment will do. Part of a business plan. Also see business plan. (6)

Financial ratios
See ratio analysis. (3)

Financial risk
The variation in a firm’s financial performance caused by using borrowed money (debt, leverage). (3)

Financial statements
Reports created from accounting records that summarize a firm’s performance and position in money terms. The three principal statements are the income statement, balance sheet, and statement of cash flows. (2)

Financing activities
Deal with the capital accounts: long-term debt and equity. (2)

Financing lease
A lease in which the lessee effectively acquires ownership of the leased asset. Also called a capital lease. Accounted for by showing the leased asset on the balance sheet offset by a liability representing the obligation to make future lease payments. Compare with operating lease. (9)

Fixed financial charge
An expense item that must be paid regardless of how the firm is performing. Essentially, interest and lease payments. (3)

Float
Money tied up in the cheque-clearing process. (4)

Floating exchange rate
In foreign exchange markets, a rate determined essentially by global supply and demand for the currency, with little intervention by governments (20)

Floor broker
A broker who buys and sells on the trading floor of a stock exchange, for example, the New York Stock Exchange. (7)

Flotation costs
The administrative cost of issuing new securities. Consists largely of commissions and marketing fees, but printing and engraving costs can also be significant. (9)

Forecast
A short-term projection of a company’s financial results. For example, most firms do regular cash forecasts to predict their immediate funding needs. Also see cash budgets. (6)

Foreign bond
A bond denominated in the currency of the country in which it is sold, but issued by a foreign borrower. Compare with eurobond. (20)

Foreign direct investment (FDI)
In international business, building or buying facilities in another country. (20)

Foreign exchange
A general term for the currency of foreign countries. (20)

Foreign exchange market
A financial market in which the currencies of different countries are traded. (20)

Free cash flow
Cash generated by a business above that needed for asset replacement and growth. (2)

Fundamental analysis
A systematic process in which a security is valued by estimating the performance of the underlying company and the future cash flows associated with owning the security. These are discounted to arrive at an intrinsic value for the security. (10)

Funds
Generally another term for cash. (15)

Future value
The amount a present sum will grow into at a specified interest rate over a specified period of time. (8)

G

GAAP
See generally accepted accounting principles.

Generally accepted accounting principles (GAAP)
The general rules by which financial records are kept and financial statements are presented. (3)

Going concern value
The value of a firm as a profit earning business as opposed to as a collection of assets. (3)

Gordon model
A mathematical model for valuing shares based on an assumed constant growth rate of dividends into the indefinite future. (10)

Government intervention
In foreign exchange markets, governments may intervene to keep exchange rates within desirable limits. (20)

Greenmail
To avoid an unfriendly acquisition, a firm may buy shares owned by a potential acquirer at a price above the market price of the shares. The above-market payment is greenmail. (19)

Gross margin
Revenue less cost of goods sold where cost is spending closely associated with production. (2)

Gross profit margin
The difference between a firm’s revenue and its product costs. Defined as Gross margin ÷ Sales. Stated as a percent of revenue. A fundamental measure of a business’s strength. (3) Also see gross margin.

H

Hedging
A manoeuvre or contract that eliminates risk from a transaction. In international trade, eliminating exchange rate risk by purchasing a forward contract for delivery of foreign exchange at a specified rate at a specified time. (20)

Holding company
A company that owns other companies. A parent company. (19)

Horizontal merger
A merger between companies in the same line of business, usually as competitors. (19)

I

Imbedded annuity
A series of regular payments within an uneven stream of payments. (8)

Income statement
Financial statement showing revenue earned and costs and expenses incurred over the accounting period. (2)

Income tax
A percentage of net income paid by a taxpayer (whether an individual or a corporation) to the taxing authority. The tax is levied on a base of taxable income, which is income subject to tax, less certain tax deductions. (2)

Inconvertible currency
In foreign exchange markets, a currency that cannot be exchanged for other currencies at market-determined rates. The foreign government involved will sell its currency at its official exchange rate. However, if you have the foreign currency, there is generally no one willing to buy it for dollars or any other major currency at the exchange rate set by the foreign government. (20)

Incremental cash flows
The change in cash flows, after tax, that result from making a business decision, such as a capital investment. (13)

Indentures
Contractual agreements associated with bonds that limit the activities of the issuing companies. The limitations are designed to reduce the risk that the firm won’t be able to pay the bond’s interest and principal. (9)

Independence hypothesis
In capital structure theory, the original restrictive model by Modigliani and Miller that shows share price to be independent of capital structure. (16)

Initial public offering (IPO)
Shares in a new company offered to the public for the first time. Such shares tend to make a volatile, high-risk investment. Also see primary market. (7)

In play
A company is in play when it is the object of an acquisition attempt. (19)

Insider information
Information about companies that can influence share price that is available to insiders but not to the general public. It is illegal to make short-term profits using insider information. (7)

Insolvency
A firm is technically insolvent when it can’t pay its short-term debts. Legal insolvency implies that the firm’s liabilities exceed its assets. Also see bankruptcy. (19)

Institutional investor
A business organization that buys and sells securities. Generally a fund of some kind, such as a mutual fund or a pension fund that invests the pooled money of its clients. (7)

Interest
The return on a debt investment. (7)

Interest rate model
An abstract portrayal of how interest rates work. (7)

Interest rate risk
The risk of loss to an investor from changes in the price of a bond that arise from changes in the market interest rate. Also called price risk and maturity risk. (7)

Internal rate of return (IRR)
A capital budgeting technique that rates projects according to their expected return on invested funds. The higher the return, the better. (12)

International bond
A bond sold outside the home country of the issuing organization (borrower). May be a foreign bond or a eurobond. (20)

Intrinsic value
An underlying or fundamental value. In securities analysis, the price of a security (usually a share) derived from extensive analysis of the issuing company and its industry. In financial options, the difference between the market price of the underlying share and the price at which an option on that share can be exercised (the strike price) if that difference is positive, zero if it is not. (10)

Inventory carrying costs
Costs associated with holding inventory, including financing charges, storage and security, insurance, taxes on assets, shrinkage, damage, and obsolescence. Compare with inventory ordering costs. Also see economic order quantity model. (4)

Inventory ordering costs
The expenses of placing orders with suppliers, receiving shipments, and processing materials into inventory. Compare with inventory carrying costs. (4)

Inventory turnover ratio
Cost of goods sold (or sales) divided by inventory. A financial ratio that indicates whether or not a firm has excess funds tied up in inventory. (3)

Invest (investing, investment)
Using a resource (usually money) to improve the future rather than for current consumption. Investment by companies generally means buying assets to be used in their businesses. Investment by individuals usually means buying financial assets (shares, bonds, savings accounts) that earn a return. (1)

Investing activities
Occur when the firm buys (invests in) or sells things such as equipment that enable it to do business; also include purchases and sales of long-term financial assets. (2)

Investment dealer
An organization that assists companies in issuing securities and selling them to investors. (5)

Investment grade bonds
Bonds above a certain quality rating. DBRS: BBB; S&P: BBB. (9)

Investment opportunity schedule (IOS)
A schedule of capital budgeting projects arranged in decreasing order of IRR. (15)

Iterative technique
A procedure that finds a solution to a problem through a repetitive series of calculations. Also known as a numerical method. (6)

J

Junk bonds
Risky bonds issued by heavily leveraged companies that pay high rates of interest. Also called high-yield bonds. (9)

Just in time (JIT) inventory system
In theory, manufacturing parts arrive “just in time” to be used in production, minimizing the need for inventories. (4)

L

Lead time
In inventory management, the estimated time in advance of need when a restocking order has to be placed. (4)

Leaning on the trade
See stretching payables. (2)

Lease
An agreement for the use of an asset in return for payments over a specified period. In recent years, long-term leases have often been used to acquire assets rather than purchasing them with debt or equity capital. Lease payments then become fixed financial obligations similar to interest. (9)

Letter of credit
In international trade, a letter of credit provides a bank guarantee that the exporter will be paid according to the contract of sale if all of the underlying agreements are met. To reduce its credit risk, the exporter asks the foreign importer (customer) for a letter of credit from the importer’s bank, guaranteeing payment of the exporter’s invoice, provided that the exporter delivers the goods and trade documents in good order. (20)

Leveraged buyout (LBO)
A process in which an investor group buys up a company’s shares using a small amount of equity and borrowing the rest of the money required. The debt is often secured by the firm’s assets. The investor group is often the firm’s management, and the company goes from being publicly held to being privately held. (19)

Leveraged lease
A three-party leasing arrangement in which a lender extends credit to a lessor to acquire equipment which is then leased to a user. The loan is usually secured by the leased equipment. Sophisticated tax advantages are associated with the technique. (9)

Limited liability
An advantage of the corporate form. Shareholder liability for the actions of a company is limited to amount invested. That is, a claim against the corporation cannot be made against a shareholder simply because the shareholder is an owner. (1)

Line of credit
A relatively informal, nonbinding agreement with a bank as to the maximum amount a firm can borrow during a period of time. (5)

Liquidation
Ending a firm’s life by selling off its assets. (19)

Liquidity
With respect to a company, the ability to pay its bills in the short run. With respect to an asset, the readiness with which it can be converted to cash. (2)

Liquidity ratios
Financial ratios that measure the firm’s ability to pay its upcoming liabilities when due. Examples include the current ratio and the quick ratio. Also see ratio analysis. (3)

Liquidity preference theory
A theory of the shape of the yield curve. The curve slopes upward because, all other things equal, investors prefer shorter, more liquid investments. They must therefore be induced to lend longer with higher rates. (7)

Liquidity risk
The risk of loss to an investor from the inability to sell a security to another investor at a price close to its true value. (7)

Listed company
A firm that is traded on an organized exchange is “listed” on that exchange. Unlisted companies are traded, not on an exchange, but on the over-the-counter market in Canada. Also see exchange (7)

Lock box system
A service provided by banks to accelerate the collection of cash once a cheque has been mailed to a payee. Its purpose is to shorten float. Also see float. (4)

Long-term debt
Usually consists of bonds and long-term loans. (2)

Loss carryovers
The tax system allows corporations with a business loss or net capital loss in a year to apply these losses to prior years or future years to recover or reduce taxes. See also tax loss carryback. (2)

M

Marginal cost of capital (MCC)
The cost of the next dollar of capital to be raised. (15)

Marginal cost of capital (MCC) schedule
A plot of the WACC (weighted average cost of capital) against the total amount of capital to be raised in a planning period. The MCC rises as more capital is raised and the costs of individual components experience step function increases. (15)

Marginal tax rate
The rate at which the next dollar of income will be taxed. Generally the taxpayer’s bracket rate. Also see tax rate, tax bracket. (2)

Market to book value ratio
A financial ratio that is a broad indicator of what the market thinks about a particular share. Defined as Share price ÷ Book value per share. (3)

Marketable securities
Highly liquid short-term debt investments held by companies instead of cash. Marketable securities provide nearly the liquidity of cash but earn a modest return. Also referred to as near cash or cash equivalents. (2)

Market risk
Variation on the return on a share investment caused by things that tend to affect all shares. Contrast with business-specific risk. (11)

Market segmentation theory
A theory of the shape of the interest yield curve. The debt market is segmented by term, and each segment is independent of the others. Hence, the curve slopes upward or downward depending on supply and demand conditions in the various market segments. (7)

Market value added (MVA)
The excess of market value measured by the product of share price and the number of shares outstanding over the book value of equity. An indication of the effectiveness of management in contributing to shareholder wealth. Also see economic value added. (3)

Market value ratios
Financial ratios that compare certain financial statement figures to the value the stock market places on the firm. Examples include the price/earnings ratio and the market to book value ratio. Also see ratio analysis. (3)

Matching principle
Concept that recognition of an asset’s cost should match its service life. Also see amortization. (2)

Maturity
The date on which the principal of a debt is due. Also the time from the present until that date. (4)

Maturity matching principle
The idea that the maturity of financing should match the duration of the asset being financed. (4)

Maturity risk
The risk of loss to an investor from changes in the price of a bond that arise from changes in the market interest rate. Also called price risk and interest rate risk. The term maturity risk emphasizes the fact that interest-induced price changes are larger with longer maturities. (7)

Merger
The combination of two or more businesses under one ownership in which all but one legal entity cease to exist, and the combined organization continues under the name of the surviving firm. When the surviving firm acquires the shares of the other(s), the transaction can be called an acquisition. A merger is friendly if it has the approval and support of the acquired (target) firm’s management. It is unfriendly if the target’s management resists. The term “merger” tends to be used loosely to refer to any business combination. (19)

Money market
A financial market in which short-term (less than one year) debt securities are traded. (7)

Monte Carlo simulation
A capital budgeting technique for incorporating risk into capital budgeting. The approach involves the use of numbers drawn randomly from probability distributions for each future cash flow in a capital budgeting project, in order to provide a good approximation of the probability distribution of the project’s NPV. (14)

Mortgage bond
A bond secured by real estate. (9)

Mortgage loan
A loan secured by real estate. Commonly referred to simply as a mortgage. (8)

Multinational corporation (MNC)
A company with wholly or partially owned affiliates in foreign countries. (20)

Mutual fund
An investment vehicle in which investors contribute to a fund that uses their pooled money to invest in shares, bonds, and other financial assets. The fund owns the assets, while the investors own shares or units of the fund. (1)

Mutually exclusive projects
In capital budgeting, projects that automatically exclude one another. Projects are mutually exclusive either because they’re different approaches to doing the same thing or because limited resources preclude doing more than one. Contrast with stand-alone project. (12)

N

NASDAQ
A segment of the U.S. stock market that deals in publicly traded stocks that are not listed on an organized exchange. NASDAQ is an acronym for the National Association of Securities Dealers Auto-mated Quotation system over which shares are traded. (7)

Net present value (NPV)
A capital budgeting technique that rates projects according to the total present value of all their associated cash flows, both positive and negative. The higher the total or net present value, the better. (12)

Net present value profile
A project’s NPV profile is a graph of its NPV versus the cost of capital. It crosses the horizontal axis at the IRR. (12)

Net working capital
See working capital. (2)

Nominal interest rate
The named or quoted rate usually stated on an annually compounded basis. May be different from the effective rate due to non-annual compounding. (8)

Noncash charge
An item of cost of goods sold or expense in the income statement that doesn’t require cash. The primary example is amortization. (2)

Normal growth
In share pricing models, dividend growth at a rate less than the expected rate of return. Growth rates in excess of the rate of return are super normal. (10)

Note
A security reflecting an intermediate-term debt relationship between the issuer and the holder. (8)

O

Off balance sheet financing
Acquiring the use of assets without adding debt to the balance sheet. The primary example is an operating lease. The details of off balance sheet financing must be disclosed in the notes to financial statements. (9)

Operating activities
The things that a company does on a day-to-day basis to conduct its business; they involve the income statement and current balance sheet accounts. (2)

Operating cycle
The time from the acquisition of inventory until cash is collected from product sales. Compare with cash conversion cycle. (4)

Operating lease
A lease in which the lessee does not effectively acquire ownership of the leased asset. Accounted for as a stream of expense payments on the income statement. No entry is made on the balance sheet to reflect the acquisition of the asset. Compare with financing lease. (9)

Operating leverage
The use of fixed as opposed to variable cost in a firm’s cost structure. (16)

Operating loan
Produces financing for working capital and expenses. (5)

Operating plan
A short- to intermediate-term business plan addressing a firm’s methods and goals over the period covered. Most companies have an annual operating plan. Also see business plan. (6)

Operating profit
A business’s profit before consideration of financing charges. Also called earnings before interest and taxes. (2)

Opportunity cost
The benefit forgone by using an asset in a particular way. Usually the income or benefit it would produce in its next best use. (5)

Option
The contracted right to buy or sell a security at a fixed price within a predetermined period of time, usually three to nine months. Options give speculators the chance to profit on movements in securities’ prices without actually owning those securities. For example, the owner of an option to buy will profit if the underlying security’s market price rises substantially above the price specified in the option during the option period. (18)

Option (real)
See real option. (14)

Option price
The price an option holder pays for a contract. Also known as the option premium in financial options. (14)

Over the counter (OTC) market
A network of securities dealers who trade unlisted (on an exchange) shares for clients. (7)

P

Partnership
A form of business organization in which two or more people agree to share in the business. The two common types of partnerships are general (all partners share in the management and liabilities) and limited (limited partners provide cash for the partnership to operate, but the general partners make the decisions). (1)

Payback period
A capital budgeting technique that rates projects according to the speed with which they return invested money. (12)

Payment date
The date on which a dividend cheque is mailed. (17)

Pegged (fixed) exchange rate
An exchange rate set by the government of a country, which attempts to maintain the rate against exchange market pressures. The rate normally is set at a fixed (or semi-fixed) relationship with respect to the U.S. dollar, or one of the other major currencies. (20)

Percentage of sales method
A simple, approximate approach to forecasting financial statements for an existing business involving estimating the company’s sales growth rate, and assuming that all income statement and balance sheet line items grow at the same rate (vary directly with revenue). Implicitly assumes that the firm’s efficiency and all of its operating ratios stay the same through the growth period. (6)

Permanent working capital
The minimum levels of current assets required to operate a business. (4)

Perpetuity
An infinite series of equal payments at equal intervals of time. (8)

Perquisites
Privileges and luxuries provided to executives. (1)

Personal guarantee
Generally, a guarantee made by the owner of a small business corporation when a loan is made to the business. The owner pledges his or her personal assets in addition to that of the company. Personal guarantees circumvent the limited liability feature of the corporate form in the context of lending to small businesses. (1)

Personal tax system
The system devised by the federal and provincial/territorial governments to extract a proportionate share of individuals’ income. (2)

Planning assumption
An assumption about the future on which a business plan is based. The assumption must be reflected in the firm’s financial projections by calculating the specific financial statement figures it implies. Also see business plan. (6)

Planning horizon
The time a business plan covers. Typically between a few months and five years. (6)

Pledging receivables
Borrowing money using receivables as collateral. (5)

Poison pill
A corporate tactic to avoid being acquired. A poison pill is a clause written into a firm’s bylaws that makes it prohibitively expensive for an acquiring firm to take control. (19)

Political risk
In international business, the chance that the value of a firm’s investment in a foreign country will be reduced by political actions of either the foreign government or terrorists. Also see expropriate. (20)

Portfolio
In finance, a collection of investments. (1)

Portfolio investment
In international finance, investment in the securities of a foreign company or government. (20)

Portfolio theory
A body of thought aimed at forming investment portfolios that minimize risk for a given return. (11)

Preauthorized cheque
A signed cheque-like document given by a payer to a payee in advance of receiving goods or services. (4)

Precautionary demand
The cash in the bank that firms need for emergency needs. Compare with transactions demand and speculative demand. (4)

Preemptive rights
A shareholder’s right to maintain her proportionate ownership in a corporation. The shareholder has the right to buy a share of any newly issued stock that is proportionate to her fractional ownership of the company before the new issue. The right is not a matter of law but must be written into the corporation’s bylaws. (10)

Preferred share or preferred stock
A security that pays a constant dividend “forever.” A hybrid between a bond and a common share. (10)

Present value
The value today of a sum promised at a specified time in the future given a rate of interest. The amount that would have to be deposited today at the specified interest rate to grow into the promised sum on the specified date. (8)

Price/earnings (P/E) ratio
The ratio of a firm’s sthare price to its earnings per share (EPS). A measure of the value the stock market places on the company and its future prospects. (3)

Primary market
A subdivision of financial markets in which securities are sold for the first time. The sale is by the issuing company to investors. Also see initial public offering. Compare with secondary market. (7)

Prime rate
The interest rate banks charge their best commercial and private customers. (5)

Privately held company
A company that is not registered with a securities commission, whose securities therefore may not be sold to the general public. Also called a closely held company. (7)

Profitability index (PI)
A capital budgeting technique that rates projects according to the ratio of the present value of cash inflows to the present value of cash outflows. Essentially a variation on the NPV technique. The higher the PI the better. (12)

Profitability ratios
Financial ratios measuring the profit performance of a firm. They include return on sales (ROS), return on assets (ROA), and return on equity (ROE). Also see ratio analysis. (3)

Progressive tax system
An income tax structure in which higher incomes are taxed at higher rates. (2)

Promissory note
A lending agreement in which the borrower promises to pay principal and interest in accordance with specific terms. (5)

Proprietorship
A form of business organization in which the business is indistinguishable from the owner; business profit is taxed as personal income to the business owner. (1)

Prospectus
A document disclosing the details of a security and the underlying business to prospective investors. (7)

Proxy
The right to act for another on a specific issue. In finance, the right to cast another’s vote in the election of corporate directors. Incumbent directors routinely solicit shareholders’ proxies for reelection. (10)

Proxy fight
A fight for control of a corporation when two or more interests compete for the proxies of shareholders in the election of directors. (19)

Publicly traded company
A company that is registered with a securities commission and whose securities therefore may be sold to the general public. (7)

Pure interest rate
The earning power of money. An interest rate without an inflation component or premiums for risk. (7)

Pure play company
A firm in a single line of business, as opposed to a firm with divisions in several businesses. (14)

Put (option)
The right to sell a stock to another at a specified price over a designated period of time. See option. Compare with call option. (18)

Q

Quick ratio
Current assets less inventories divided by current liabilities. A financial ratio that measures a firm’s liquidity, the ability to pay its bills in the short run, without depending on converting inventory into cash. Also called the acid test. (3)

R

Ratio analysis
A technique of analyzing the strength of a company by forming (financial) ratios out of sets of numbers from the financial statements. Categories include profitability ratios, asset management ratios, liquidity ratios, debt management ratios, and market value ratios. Ratios are compared with the competition, recent history, and the firm’s plan to assess the quality of its performance. (3)

Real asset
A tangible object with value derived from the service it provides, such as a house or a car. Distinguish from a financial asset, which is a piece of paper giving its owner a claim to future cash flows. (1)

Real interest rate
The interest rate that currently exists less the inflation adjustment. (7)

Real option
The ability to take a course of action that under certain circumstances leads to a benefit. The circumstances that make the action desirable are uncertain, and maintaining the ability to take it requires expenditures before that uncertainty is resolved. Hence, bearing the preliminary cost gives one the option of taking an action in the future that may or may not turn out to be desirable. Real options may increase the estimated NPV of a project and reduce its risk. Common examples include abandonment options, expansion options, investment timing options, and flexibility options. (14)

Red herring
A prospectus for the sale of a security not yet approved by a securities commission. Stamped with the word “PRELIMINARY” in red letters. (7)

Registered bond
Bond for which the issuer or a transfer agent keeps a list of the names of owners. Interest payments are made to owners of record as of specified dates. Contrast with bearer bond (9)

Reinvestment assumption
In capital budgeting, the rate of compound interest at which future cash flows are assumed to be reinvested. In NPV analysis, this rate is the cost of capital used. In IRR analysis, this rate is the internal rate of return. (12)

Reorder point
The inventory level at which an order is placed with a supplier. Calculated so that the expected usage during the ordering lead time will bring the stock to its lowest planned level just as the new supply is delivered. See also lead time. (4)

Reorganization
In bankruptcy, a plan to restructure the failing company so that it may continue in business. (19)

Required return
The minimum return that keeps an investor in a particular share. Generally a function of the risk perceived in the investment. (11)

Residual claim
Shareholders’ claim to income and assets is the residual after all other claims are satisfied. (10)

Residual dividend theory
The idea that corporations pay dividends with whatever money is left over out of earnings after all projects with a positive NPV are undertaken. (17)

Residual value
The value of a leased asset at the termination of the lease. (9)

Restrictive covenants
Contractual agreements associated with loans that limit the activities of borrowing companies. The limitations are designed to reduce the risk that the firm won’t be able to pay the loan’s interest and principal. (9)

Restructuring
A change in a bankrupt firm’s debt obligations aimed at allowing it to continue in business. In an extension, creditors agree to give the firm longer to pay. In a composition, creditors agree to settle for less than the full amount owed. (19)

Retained earnings
Profits that have not been distributed to shareholders as dividends. Together with common and preferred shares outstanding, retained earnings form a portion of shareholders’ equity. (2)

Return
The payment to an investor for the use of funds. Usually expressed as a percent of the investment. (7)

Return on assets (ROA)
Net income divided by total assets. A financial ratio measuring performance concentrating on profitability and asset utilization. (3)

Return on equity (ROE)
Net income divided by equity. A financial ratio measuring performance concentrating on profitability, asset utilization, and the use of borrowed money. (3)

Return on sales (ROS)
Net income divided by sales revenue. A financial ratio measuring performance concentrating on profitability. (3)

Reverse stock split
A method used to reduce the number of shares outstanding. A company issues one new share for a certain number of old shares. Once the process is complete the share price is higher and the number of shares in issue is lower. Reverse stock splits are usually due to a significant decline in the share’s price. Compare with share repurchase. (17)

Revolving credit agreement
A formal, binding agreement with a bank as to the maximum amount a firm can borrow during a period of time. Interest is paid on the amount borrowed and a commitment or standby fee is paid on the unused balance. Compare with line of credit. (5)

Risk
In finance, the probability that the return on an investment will be more or less than expected. The variability of the return on a particular investment. The variance of the probability distribution of return. (7)

Risk-adjusted rate
In capital budgeting, a higher rate used in place of the cost of capital to reflect especially risky projects. (14)

Risk aversion
The premise that most people prefer lower risk investments when expected returns are about equal. (11)

Risk-free rate
The interest rate excluding all risk premiums. The risk-free rate consists of the pure rate and an inflation adjustment. It is approximated by the three-month Treasury bill rate. Written as kRF. (7)

Risk premium
A component of a rate of interest or return that compensates the investor for bearing some kind of risk. (7)

ROA
See return on assets. (3)

ROE
See return on equity. (3)

ROS
See return on sales. (3)

S

Safety stock
Extra inventory carried to prevent stockouts in the event of heavy demand or delayed delivery. (4)

Scenario analysis
A business planning technique in which the implications of variations in planning assumptions are explored. Also known as “what if”-ing. (6)

Seasoned issue
An older bond. (9)

Secondary market
Sales of existing securities between investors. Compare with primary market. (7)

Secured debt
Debt backed by specific assets (the security or collateral) that become the property of the lender in the event of default. (19)

Securities analysis
A systematic approach to valuing securities, especially shares, by studying an issuing firm’s business and industry. The securities analyst plays an important role in the financial industry. (10)

Securitization of receivables
Financing technique that involves the sale of receivables by large firms in public offerings arranged by securities dealers. The issuing firm thus receives immediate cash for future cash flows. (5)

Security
A financial asset. Commonly a share or a bond. An asset pledged to guarantee the repayment of a loan. (1)

Security market line (SML)
The central element of the CAPM. The SML purports to explain how the market sets the required return on a share investment. (11)

Self-liquidating debt
Debt that is paid off when the item financed becomes cash in the borrower’s hands. Also see maturity matching. (4)

Senior debt
The debt having priority over a subordinated debenture. (9)

Share
A financial asset representing a share of ownership of a corporation. Entitles the owner to dividends if any are paid. Also called stock. Shares may be preferred or common. Also see common share. (1)

Signalling effect
The idea that dividends send a message about management’s confidence in the future of the firm—that is, paying a regular or increased dividend signals that the firm is fundamentally sound even if it appears to be having problems. The signalling idea leads to the practice of holding dividends constant or raising them in the face of poor financial performance. Also known as the information effect of dividends. (17)

Sinking fund
A series of payments made into an account dedicated to paying off a bond’s principal at maturity; an arrangement to guarantee that funds are available to pay off the principal at maturity. (8)

Specialist
An official in a stock exchange. The specialist is assigned the shares of specific companies and is responsible for conducting an orderly market in those securities. (7)

Speculation
The assumption of measured risks in the hope of financial gain, usually with substantial knowledge of the processes that generate gains and losses. (19)

Speculative demand
The cash that firms keep in the bank to take advantage of unexpected opportunities. Compare with transactions demand and precautionary demand. (4)

Spinoff
A method of divesting a business unit by setting it up as a separate company and giving its shares to shareholders in proportion to their holdings of the original firm. After the spinoff, shareholders can trade the two stocks separately. (19)

Spontaneous financing
Financing provided by current liabilities that arises automatically as a result of doing business. Examples are trade credit and accruals. (4)

Stable dividend
A dividend that may remain constant or increase over time but that does not decrease. (17)

Stand-alone project
In capital budgeting, a project with no competition either for the task it is to accomplish or for resources. Contrast with mutually exclusive projects. (12)

Stand-alone risk
The risk associated with investing in a share that’s held by itself, outside of a portfolio. Stand-alone risk depends on the volatility of a share’s own return rather than on the effect its inclusion has on the volatility of the return of a portfolio. (11)

Standby fee
See commitment fee. (5)

Statement of Cash Flows
One of a firm’s financial statements. Constructed from the income statement and balance sheet, it details the movement of cash in and out of the company due to operating activities, investing activities, and financing activities. Operating activities have to do with running the business on a day-to-day basis. Investing activities occur when the firm buys (invests in) or sells things such as equipment that enable it to do business. Financing activities have to do with raising money and servicing the obligations that come along with it. (2)

Stockbroker
A person licensed to assist investors in buying and selling securities for a commission. (1)

Stock dividend
Essentially a stock split. A stock dividend is the payment to common shareholders of a dividend in the form of common shares. In the case of a 10% stock dividend, a shareholder with 100 shares would receive 10 additional shares. See stock split. (17)

Stock exchange
A physical place in which stocks are traded by brokers on behalf of their investor clients. Also see exchange. (7)

Stock market
The network of exchanges, brokers, and investors that trade in shares. (1)

Stockout
An inventory shortage. (4)

Stock split
A change in the number of shares outstanding by issuing new shares in proportion to those already owned. All shareholders’ proportionate ownership is maintained, and no economic value is created. Used to keep share prices within a desirable trading range. (17)

Strategic plan
A long-term business plan addressing broad issues of what a company’s management wants it to become and how it is to do business. (6)

Stretching payables
Paying invoices after they’re due according to the terms of sale. Also called leaning on the trade. (2)

Strike price
The price at which an optioned share can be bought or sold. Also called the exercise price or striking price. Also see option. (18)

Subordinated debt
Debt with a lower priority for the payment of interest and principal than other (senior) debt. (9)

Sunk cost
In capital budgeting, a cost associated with a project expended prior to making the decision to undertake that project (for example, the cost of research into the idea). Since sunk funds are already gone, they cannot alter future costs or benefits, and should not be included in the analysis leading to a decision. (13)

Sustainable growth rate
The rate at which a firm can grow if none of its financial ratios changes and it doesn’t raise any new equity by selling shares. The growth in equity created by earnings retained. (6)

Synergy
A situation in which two companies operating together under one ownership perform better than the sum of their separate performances. A popular reason claimed for mergers. (19)

T

Takeover
The transfer of control over a company from one group to another. The term generally has a hostile implication. (19)

Target
The company that is the object of a corporate acquisition or merger. See merger. (19)

Target capital structure
The capital structure that management strives to maintain as new capital is raised. An estimate of the structure that maximizes share price. (15)

Taxable capital gain
The portion of a capital gain that is subject to income tax, currently 50%. Also see capital gain. (2)

Taxable income
Income tax is levied on a base of taxable income, which is income subject to tax, less certain tax deductions. Also see tax deductions. (2)

Tax amortization
An incentive to business provided by the Canadian government and the Canada Revenue Agency that involves capital cost allowance (CCA), which provides a tax-deductible expense for accelerated amortization (depreciation). Higher amortization in a given year results in lower tax in that year, because taxable income is lower. (2)

Tax books
Financial records and statements generated by using the tax rules. They differ from the financial books primarily in the area of amortization. (2)

Tax bracket
A range of income over which the tax rate is constant. The tax rate is higher, the higher the tax bracket. The bracket rate is usually the marginal tax rate for taxpayers in that bracket. Normally taxpayers will pay that rate on their last dollar of income. Also see marginal tax rate, progressive tax system. (2)

Tax deductions
Costs and expenses that can be deducted from income to reduce taxable income. Also see taxable income. (2)

Tax loss carryback (or carryforward)
The allocation of losses in a year to previous or subsequent years for the purpose of calculating taxes in those years. Currently losses may be carried back three and forward seven years. (2)

Tax rates
Combined rates levied by the federal and provincial governments on taxable income to determine tax payable. The average tax rate is a composite of the various bracket rates to which the taxpayer’s income is subject. It is the percentage of taxable income paid in income taxes. Equals a taxpayer’s total tax bill divided by taxable income. Also see tax bracket, taxable income. (2)

Technical analysis
An approach to valuing securities by examining past patterns of price and volume. The technique is based on the idea that such patterns repeat themselves. (10)

Temporary working capital
The additional levels of current assets required to support seasonal peaks in the business. Compare with permanent working capital. (4)

Tender offer
A general offer to shareholders to purchase shares at a specified price, usually for the purpose of acquiring a company. (17)

Term
The time until a debt security’s principal is due to be repaid. Also called the debt’s maturity or time until maturity. (7)

Terminal (salvage) value
The estimated proceeds on disposal, if any, of an asset at the end of its useful life. (12)

Terms of sale
The conditions under which a sale is made primarily with respect to payment. Terms include a date on which payment is due and often specify a prompt payment discount that may be taken if payment is made within a specified time. (2)

Time premium
In an option, the difference between intrinsic value and the option price. (18)

Time value of money
Calculations involving the present and future values of money under the action of compound interest. Also called discounted cash flow. (8)

Top-down planning
Business planning based on a set of goals forced on the organization by senior management. Top-down planning has a tendency to lead to excessively optimistic plans. Contrast with bottom-up planning. (6)

Total asset turnover
A financial ratio measuring the relationship of the firm’s assets to the year’s sales. Defined as Sales ÷ Total assets. (3)

Total effective tax rate (TETR)
The combined income tax rate including federal and provincial tax. Less than the sum of the two because federal tax provides a tax credit for provincial tax. Also called average tax rate, combined tax rate. Also see tax rates. (2)

Trade credit
Credit granted in the normal course of business between companies. That is, vendors don’t usually demand immediate payment for their products. (2)

Trading range
A price range in which shares are thought to appeal to the widest variety of investors. Typically between $10 and $50. Stock splits function to keep prices within a trading range when the share is appreciating. (17)

Transaction costs
The costs of trading securities, including brokerage commissions. (17)

Transactions demand
The cash in the bank that firms need to pay bills for the goods and services they use. Compare with speculative demand and precautionary demand. (4)

Transfer agent
An organization that keeps records of the owners of a company’s securities. When a security is sold by one investor to another, ownership is transferred on the record by the transfer agent. Transfer agents are often trust companies. (9)

Translation risk
In foreign direct investments, refers to the unrealized gain or loss that arises from translating the financial statements of a foreign subsidiary from the local currency into Canadian dollars for consolidation with the parent company’s financial statements. If the Canadian dollar is weak on the day that accounts in foreign currencies are translated into Canadian dollars, the exchange rate may give a lower dollar value for the net income and net assets of the foreign subsidiary. This difference implies that the foreign subsidiary has lost value in terms of dollars. Thus, translation losses are unrealized and reflect the exchange rate on that date only. Compare with economic risk. (20)

Treasurer
The executive in charge of external financing in most large companies. The treasurer generally reports to the CFO. (1)

Treasury bill
A short-term obligation of the federal or provincial governments with maturities up to one year. Sold in the money market at a discount. (7)

Trust receipt
Also known as a chattel mortgage agreement, this is an inventory loan arrangement in which the financed inventory is identified by serial number and cannot be sold legally without the lender’s permission. When the items are sold, the proceeds must be used to repay the lender. Under a warehousing arrangement, the financed inventory is placed in a warehouse and the borrower’s access to it is controlled by a third party. Compare with blanket inventory lien, warehousing. (5)

Trustee
With respect to bonds, an organization that ensures compliance with the conditions set forth in the indenture. With respect to bankruptcy, a person who administers the bankrupt organization to ensure funds are properly handled. (19)

U

Undepreciated capital cost
The undepreciated value of assets remaining in an asset class that is the basis for the amount of CCA claimed. UCC for tax purposes is comparable to net book value for accounting purposes, although differences often exist. Also see capital cost allowance, book value. (13)

V

Valuation
A systematic process to determine the price at which a security should sell in financial markets. (9)

Value of capital
In cost of capital, the value of capital can be stated based on the book or market prices of the underlying securities. Book values reflect the prices at which the securities were originally sold and the cost of capital already spent. Market values reflect the current market prices of those same securities and estimate the cost of capital to be raised in the near future. For calculating the WACC, market values are appropriate because new projects are generally funded with newly raised money. (15)

Vertical merger
A merger between companies when one is a supplier or a customer of the other. (19)

W

Warehousing
In finance, a method of securing the lender’s interest when borrowing is secured by inventories. The inventory is placed in a warehouse operated by a third party. When it is drawn out of the warehouse by the borrower, a pro rata share of payment on the loan is due. Compare with trust receipt. (5)

Warrant
A security that grants its owner the right to purchase one or more shares at a designated price over a limited period. Similar to a call option except that a warrant is issued by the company that issued the underlying shares while a call is issued (written) by another investor. Also different in that warrants tend to be exercisable over much longer periods than calls. (18)

Weighted average cost of capital (WACC)
See cost of capital. (15)

“What if”-ing
See scenario analysis. (6)

White knight
When a firm is an acquisition target by an unattractive suitor, a more desirable acquirer is known as a white knight. (The original suitor may be known for particularly ruthless treatment of acquired companies.) (19)

Widely held company
A corporation whose ownership is distributed over a large number of people with no single individual or group having a significant proportion. (1)

Working capital
The balance sheet accounts associated with day-to-day operating activities. Gross working capital is generally defined as current assets and net working capital as current assets minus current liabilities. Permanent working capital is the minimum levels of current assets required to operate a business. Temporary working capital is the additional levels of current assets required to support seasonal peaks in the business. (2)

Y

Yield
See return. (7)

Yield curve
The relationship between interest rates and the term of debt, generally expressed graphically. A normal yield curve is upward-sloping, reflecting rates that increase with increasing term. An inverted curve is downward-sloping. (7)

Yield to call (YTC)
Bond pricing calculations assuming the bond will be called at the end of the protected period. (9)

Yield to maturity (YTM)
The average annual rate of return required by investors over the remaining term of a bond; affected by market interest rates, the time remaining to maturity, and the bond’s rating. (9)

Z

Zero balance account
An empty disbursement account established at the firm’s concentration bank for its various divisions. Divisions write cheques on their ZBAs that are automatically funded out of a master account at the concentration bank as they’re presented for payment. (4)

Zero coupon bond
A bond that pays no interest during its life. A “zero” sells for the present value of the principal repayment. However, Canada Revenue Agency imputes interest during the bond’s life on which the bondholder must pay tax. (9)

 

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