Appendix
Glossary: Slashing Through the Accounting Jargon Jungle
ABC: The acronym for activity-based costing, which is a cost allocation scheme that allocates the cost of support functions in an organization (such as maintenance) based on the units of activity of the support function that are used by other departments and processes in the business.
accounting: The methods and procedures for identifying, analyzing, recording, accumulating, and storing information and data about the activities of an entity that have financial results, and preparing summary reports of these activities internally for managers and externally for those entitled to receive financial reports about the entity. A business’s managers, investors, and lenders depend on accounting reports called financial statements to make informed decisions. Accounting also encompasses preparing tax returns that must be filed with government tax authorities by the entity, and facilitating day-to-day operating functions.
accounting equation: Assets = Liabilities + Owners’ Equity. This equation expresses the fundamental duality, or two-sided nature, of accounting and is useful for explaining double-entry accounting, which uses debits and credits for recording transactions. It summarizes the balance or equality of an entity’s assets and the sources of its assets, which fall into two categories: liabilities and owners’ equity.
accounting fraud (also called cooking the books): The deliberate falsification or manipulation of accounting numbers to make the profit performance and/or the financial condition of a business appear better than reality. The term also applies to false or grossly inadequate disclosure in financial reports. But the main reference of this term is to misleading accounting methods designed with the intent to deceive. Accounting fraud can be very sophisticated and can escape discovery by the CPA auditors of a business. The incidences of accounting and financial reporting fraud, unfortunately, do not seem to have abated over the years. Accounting fraud is truly an embarrassment to the accounting profession. Accounting fraud is an unavoidable risk facing lenders and investors.
accounts payable: One main type of the short-term operating liabilities of a business, in which are recorded the amounts owed to vendors or suppliers for the purchase of products, supplies, parts, and services that are bought on credit. Generally these liabilities are non-interest bearing (although an interest charge may be added as a penalty for late payment).
accounts receivable: The short-term asset in which are recorded the amounts owed to the business from sales of products and services on credit to its customers. Customers are not normally charged interest, unless they do not pay their bills when due. The amount of this asset in a balance sheet is net of write-downs for uncollectible receivables (called bad debts).
accrual-basis accounting: Recording the financial effects of economic events when they happen, as opposed to simple cash accounting. Using accrual-basis accounting, revenue is recorded when sales are made (rather than when cash is received from customers), and expenses are recorded to match with sales revenue or in the period benefited (rather than when expenses are paid). The accrual basis of accounting is seen in the recording of assets such as receivables from customers, inventory (cost of products not yet sold), and cost of long-term assets (fixed assets) — and in the recording of liabilities such as accounts payable to vendors and payables for unpaid expenses.
accrued expenses payable: The generic term for liability accounts used to record the gradual accumulation of unpaid expenses, such as vacation pay earned by employees and profit-based bonus plans that aren’t paid until the following period. Note: The specific title of this liability varies from business to business; you may see accrued liabilities, accrued expenses, or other account title. Generally you see the term accrued in the account title.
accumulated depreciation: The total cumulative amount of depreciation expense that has been recorded since the fixed assets being depreciated were acquired. In the balance sheet, the amount in this account is deducted from the original cost of fixed assets. The balance of cost less accumulated depreciation is referred to as the book value of the fixed assets.
acid-test ratio: An alternative name for the quick ratio.
adjusting entries: At the end of the period, these important entries are recorded to complete the bookkeeping cycle. These end-of-period entries record certain expenses to the period (such as depreciation) and update revenue, income, expenses, and losses for the period. Note: This term also refers to making correcting entries when accounting errors are discovered.
amortization: Traditionally in accounting this term applied to the allocation of the cost of an intangible asset over its expected useful life to the business, in the manner of depreciation accounting. However, in recent years amortization accounting has changed gears to an annual asset impairment approach instead of a predetermined schedule for writing down the cost of the asset. (Caution: In the field of finance and investments, amortization refers to the reduction, or pay down of the principal balance of a loan.)
asset turnover ratio: Annual sales revenue divided by total assets (at year-end, or the average total assets during the year). This ratio is used to judge the utilization of assets in making sales. It is also used as one component in the calculation of return on equity (ROE).
audit report: A three-paragraph (or longer) rather technically worded opinion issued by the CPA at the conclusion of an audit, which includes testing the reliability of the accounting system of a business and scrutiny of its financial report. The CPA’s audit report states whether the financial statements and disclosures of the business are in conformity with applicable U.S. or international financial accounting and reporting standards. A so-called “clean opinion” is the best outcome of an audit; it means that the CPA auditor has no serious disagreements with the financial report of the business.
bad debt(s): The expense caused by a customer’s failure to pay the amount owed to the business from a credit sale. When the credit sale was recorded, the accounts receivable asset account was increased. When it becomes clear that this debt owed to the business will not be collected, the asset is written down and the amount is charged to bad debts expense.
balance sheet: This financial statement summarizes the assets, liabilities, and owners’ equity of a business at a moment in time. It’s prepared at the end of every profit period (and whenever else it is needed). The main elements of a balance sheet are called accounts — such as cash, inventory, notes payable, and capital stock. Each account has a dollar amount, which is called its balance. But be careful: The fact that the accounts have balances is not the reason this financial statement is called a balance sheet. Rather, the equality (or balance) of assets with the total of liabilities and owners’ equity is the reason for the name. This financial statement is also called the statement of financial condition and the statement of financial position.
book value (of assets and owners’ equity): Refers to the recorded amounts on the books (accounting records) of a business, which are reported in its balance sheet. Often this term is used to emphasize that the amounts recorded in the accounts of the business are less than the current replacement costs of certain assets, or less than the market value of owners’ equity.
break-even: The annual sales volume or sales revenue at which total margin equals total annual fixed expenses — that is, the exact sales amount at which the business covers its fixed expenses and makes a zero profit and avoids a loss. Break-even is a useful point of reference in analyzing profit performance and the effects of making sales in excess of break-even.
capital expenditures: Outlays for fixed (long-term) assets in order to overhaul or replace the old assets or to expand and modernize the long-lived operating resources of a business. Fixed assets is a broad category that includes land, buildings, machinery, equipment, vehicles, furniture, fixtures, and computers. These operating assets have useful lives from 3 to 39 (or more) years. The term “capital” implies that substantial amounts are invested for many years.
capital stock: The ownership shares issued by a corporation for capital invested in the business by owners. Total capital is divided into units of ownership called capital stock shares. In the old days, you actually got engraved certificates as legal evidence of your ownership of a certain number of shares. Today, book entry is the norm: Your ownership is recorded in the books, or records, of the registrar for the stock shares. A business corporation must issue at least one class of capital stock, called common stock. It may also issue other classes of stock, such as preferred stock.
cash flow: An ambiguous term that can refer to several different sources of or uses of cash. This term is often shorthand for cash flow from earning profit, or to me more correct cash flow from operating activities (see next entry). Some friendly advice: When using this term always make clear the particular source or use of cash you have in mind!
cash flow from operating activities: This important figure is reported in the first section of the statement of cash flows. It equals the total cash inflow from sales and other income during the period minus the total cash outflow for expenses and losses during the period. This cash flow number is higher or lower than the bottom-line net income of the business for the period, which is reported in its income statement. The sales revenue and expenses reported in the income statement are recorded using accrual basis accounting.
certified public accountant (CPA): The CPA designation is a widely recognized and respected badge of a professional accountant. A person must meet educational and experience requirements and pass a national uniform exam to qualify for a state license to practice as a CPA. Many CPAs are not in public practice; they work for business organizations, government agencies, and nonprofit organizations, or they teach accounting (a plug for educators here if you don’t mind). CPAs in public practice do audits of financial reports, and they also provide tax, management, and financial consulting services.
common stock: The one class of capital stock that must be issued by a business corporation. It has the most junior, or “last in line,” claim on the business’s assets in the event of liquidation, after all liabilities and any senior capital stock (such as preferred stock) are paid. Owners of common stock receive dividends from profit only after preferred stockholders (if any) are paid. Owners of common stock generally have voting rights in the election of the board of directors, although a business may issue both voting and nonvoting classes of common stock.
comprehensive income: Includes net income reported in the income statement plus certain technical gains and losses that are recorded but don’t necessarily have to be included in the income statement. In other words, the effects of these developments can bypass the income statement. Most companies report these special types of gains and losses (if they have any) in a column in the statement of changes in owners’ (stockholders’) equity that is headed “accumulated other comprehensive income,” or a similar title.
controller: The chief accounting officer of an organization. The controller may also serve as the chief financial officer (CFO) in a business or other organization, although in large organizations the two jobs are usually split.
cooking the books: A popular term for accounting fraud. This term should not be confused with the lesser offenses of massaging the numbers and income smoothing.
credits: see debits and credits
current assets: Includes cash plus accounts receivable, inventory, and prepaid expenses (and short-term marketable securities if the business owns any). These assets should be converted into cash during one operating cycle or sooner.
Current liabilities: Short-term liabilities, principally accounts payable, accrued expenses payable, income tax payable, short-term notes payable, and the portion of long-term debt that falls due within the coming year. This group includes both non-interest-bearing and interest-bearing liabilities that must be paid in the short term, usually defined to be one year or less.
current ratio: One test of a business’s short-term solvency (debt-paying capability). Find the current ratio by dividing a business’s total current assets by its total current liabilities.
debits and credits: Accounting jargon for decreases and increases recorded in accounts according to the centuries’ old scheme based on the accounting equation. An increase in an asset is a debit, and the ingenious twist of the scheme is that a decrease in a liability or an owners’ equity is also a debit. Conversely, a decrease in an asset is a credit and an increase in a liability or an owners’ equity is a credit. Revenue is recorded as a credit, and expenses are recorded as debits. In recording transactions, the debit or sum of debits must equal the credit or sum of credits. The phrase “the books are in balance” means that the total of accounts with debit balances equals the total of accounts with credit balances. (By the way, students have a hell of a time in learning debits and credits.)
depreciation: Allocating a fixed asset’s cost over three or more years, based on its estimated useful life to the business. Each year of the asset’s life is charged with part of its total cost as the asset gradually wears out and loses its economic value to the business. Either an accelerated method or the straight-line depreciation is used. An accelerated method allocates more of the cost to the early years than the later years. The straight-line method allocates an equal amount to every year.
dividend yield: Measures the cash income component of return on investment in stock shares of a corporation. The dividend yield equals the most recent (or trailing) 12 months of cash dividends paid on a stock divided by the stock’s current market price. If a stock is selling for $100 and over the last 12 months paid $3 cash dividends, its dividend yield equals 3 percent.
double-entry accounting: Simply put, this term means that both sides of an economic event or business transaction are recorded, both the give and the take, as it were. In short, double-entry accounting means two-sided accounting. The debits and credits method is the bookkeeping means used to implement double-entry accounting. (See debits and credits.)
earnings before interest and income tax (EBIT): Sales revenue less cost of goods sold and all operating expenses — but before deducting interest expense and income tax expense (and usually, but not always, before extraordinary gains and losses). This measure of profit also is called operating earnings, operating profit, or something similar. The idea is to have a measure of profit independent of how the business is financed (debt versus equity) and separate from how the business is taxed on its profit.
earnings per share (EPS): Equals net income for the most recent 12 months reported, called the trailing 12 months, divided by the number of capital stock shares. Dividing net income by the actual number of shares in the hands of stockholders, called outstanding shares, gives the basic EPS. Diluted EPS equals the same net income figure divided by the sum of the actual number of shares outstanding plus additional shares that will be issued under terms of stock options awarded to managers and for the conversion of senior securities into common stock (assuming that the company has issued convertible debt or preferred stock securities).
extraordinary gains and losses: Unusual, nonrecurring gains and losses that happen infrequently and that are aside from the normal, ordinary sales and expenses of a business. These gains and losses, in theory, are one-time or rare events that can’t be anticipated. But in actual practice many businesses record these gains and losses too frequently to be called nonrecurring. These gains and losses (net of income tax effects) are reported separately in the income statement. In this way, attention is directed to net income from the normal continuing operations of the business.
Financial Accounting Standards Board (FASB): The highest authoritative, private sector, standard-setting body of the accounting profession in the United States. The FASB issues pronouncements that establish generally accepted accounting principles (GAAP). Note: The federal Securities and Exchange Commission (SEC) also plays a dominant role in financial reporting by public companies in the United States.
financial leverage: Generally refers to using debt capital on top of equity capital. The strategy is to earn a rate of return on assets (ROA) higher than the interest rate on borrowed money. A favorable spread between the two rates generates financial leverage gain to the benefit of net income and owners’ equity.
financial reports: The periodic financial communications from a business (and other types of organizations) to those entitled to know about the financial performance and position of the entity. Financial reports of businesses include three primary financial statements (balance sheet, income statement, and statement of cash flows), as well as footnotes and other information relevant to the owners of the business. Public companies must file several types of financial reports and forms with the Securities and Exchange Commission (SEC), which are open to the public. The financial reports of private businesses are generally sent only to its owners and lenders.
financial statement: Generally refers to one of the three primary accounting reports of a business: the balance sheet, statement of cash flows, and income statement. Sometimes financial statements are called simply financials. Internal financial statements and other accounting reports to managers contain considerably more detail, which is needed for decision making and control.
financing activities: In accounting, this term refers to one of three types of cash flows reported in the statement of cash flows. These are the dealings between a business and its sources of debt and equity capital — such as borrowing and repaying debt, issuing new stock shares, buying some of its own stock shares, and paying dividends to shareowners.
first-in, first-out (FIFO): A widely used accounting method by which costs of products when they are sold are charged to cost of goods sold expense in chronological order. One result is that the most recent acquisition costs remain in the inventory asset account at the end of the period. The reverse order also is acceptable, which is called the last-in, first-out (LIFO) method.
fixed assets: The shorthand term for the variety of long-life physical resources used by a business in conducting its operations, which include land, buildings, machinery, equipment, furnishings, tools, and vehicles. These resources are held for use, not for sale. Please note that fixed assets is an informal term; the more formal term used in a balance sheet is property, plant, and equipment.
fixed costs: Those expenses or costs that remain unchanged over the short run and do not vary with changes in sales volume or sales revenue. Common examples are building rent under lease contracts, employees paid on salary basis, property taxes, and monthly utility bills. Fixed expenses provide the capacity for carrying out operations and for making sales.
footnotes: Footnotes are the additional explanatory items of information attached to the three primary financial statements included in an external financial report. Footnotes present detailed information that cannot be put directly in the body of one of the financial statements. Footnotes have the reputation of being difficult to read, poorly written, overly detailed, and too technical. Unfortunately, these criticisms have a lot of truth.
free cash flow: This is largely a self-defined term that depends on what you want it to mean. Be cautious about this term because it has no uniform meaning. Some people use it as an alternative term for cash flow from operating activities — to emphasize that the business is free to do what it wants with this source of cash. This is not the only usage you see in practice, however. The person using the term may deduct certain amounts from the cash flow from operating activities. For example, capital expenditures during the period may be deducted from cash flow from operating activities to determine the remaining “free” amount of cash flow. To repeat, be careful when you run into this term.
generally accepted accounting principles (GAAP): The authoritative standards and approved accounting methods that should be used by profit-motivated businesses and private nonprofit organizations domiciled in the United States to measure and report their revenue and expenses; to present their assets, liabilities, and owners’ equity; and to report their cash flows in their financial statements. GAAP are not a straitjacket; these official standards are loose enough to permit alternative interpretations.
goodwill: In accounting this term refers to intangible assets that have been purchased by a business, such as by buying an established brand name or buying a company for more than its market value. Only purchased goodwill is reported as an asset in the balance sheet. The cost of goodwill may or may not be amortized (charged off to expense over time). In the broader business sense, goodwill refers to the well-known and trusted reputation of a company. Goodwill in this usage is not found in the balance sheet. To be recorded and appear in the balance sheet of a business, goodwill must be actually purchased or acquired in the larger setting of a business combination.
gross margin (profit): Equals sales revenue less cost of goods sold expense for the period. Making adequate gross margin is the starting point for making bottom-line profit. There are other expenses below the gross margin line.
income smoothing: Manipulating the timing of when sales revenue and/or expenses are recorded in order to produce a smoother profit trend with narrower fluctuations from year to year. Also called massaging the numbers, the implementation of profit-smoothing procedures needs the implicit or explicit approval of top-level managers, because these techniques require the override of normal accounting procedures for recording sales revenue and expenses. CPA auditors generally tolerate a reasonable amount of profit smoothing — which is also called earnings management.
income statement: This financial statement summarizes sales revenue (and other income) and expenses (and losses) for a period and reports one or more different profit lines. Also, any extraordinary gains and losses are reported separately in this financial statement. The income statement is one of the three primary financial statements of a business included in its financial report and is also called the earnings statement, the operating statement, or similar titles.
internal (accounting) controls: Forms, procedures, and precautions that are established primarily to prevent and minimize errors and fraud (beyond the forms and procedures that are needed for record keeping). Common internal control are: requiring the signature of two managers to approve transactions over a certain amount; restricting entry and exit routes of employees; using surveillance cameras; forcing employees to take their vacations; separating duties; and conducting surprise inventory counts and inspections.
International Accounting Standards Board (IASB): The authoritative financial reporting standards-setting body for businesses outside the United States. The IASB and the Financial Accounting Standards Board (FASB) have been working together for more than a decade towards the adoption of world-wide accounting and financial reporting standards. However, this has proven to be more difficult than was originally imagined.
investing activities: In accounting this term refers to one of three classes of cash flows reported in the statement of cash flows. Mainly, these outlays are for major investments in long-term operating assets, typically called capital expenditures. A business may dispose of some of its fixed assets during the year, and proceeds from these disposals are reported in this section of the statement of cash flows.
last-in, first-out (LIFO): An accounting method by which costs of products when they are sold are charged to cost of goods sold expense in reverse chronological order. One result is that the ending inventory cost value consists of the costs of the earliest goods purchased or manufactured, which could be ten, twenty, or more years old. The actual physical flow of products seldom follows a LIFO sequence. The method is argued on the grounds that the cost of goods sold expense should be the cost of replacing the products sold, and the best approximations are the most recent acquisition costs.
lower of cost or market (LCM): A test applied to ending inventory that can result in a write-down and charge to expense for the decline in value of products held for sale. The recorded costs of products in inventory are compared with their current replacement costs (market price) and with net realizable value if normal sales prices have been reduced. If either value is lower, then recorded cost is written down to this lower value.
management (managerial) accounting: The branch of accounting that prepares internal financial statements and other accounting reports and analyses to help managers carry out their planning, decision-making, and control functions. Most of the detailed information in these reports is confidential and is not circulated outside the business. Management accounting includes budgeting, developing and using standard costs, and working closely with managers regarding how costs are allocated.
Manufacturing overhead costs: Refers to those costs that are indirect and cannot be naturally matched or linked with manufacturing particular products, or to a department, or to a step in the production process. One example is the annual property tax on a building in which a company’s manufacturing activities are carried out. Production overhead costs are allocated among the different products manufactured during the period in order to account for the full cost of each product. In this way, manufacturing overhead costs are absorbed into product costs and remain in the inventory asset account until the products are sold.
margin: Equals sales revenue minus cost of goods sold expense and minus all variable expenses. (In other words, margin is profit before fixed expenses are deducted.) On a per-unit basis, margin equals sales price less product cost per unit and less variable expenses per unit. Margin is an exceedingly important measure for analyzing profit behavior and in making sales price decisions.
market cap: The total market value of a public business, which is calculated by multiplying the current market price per share times the total number of capital stock shares issued by the business.
massaging the numbers: It’s also called earnings management or juggling the books, and includes the practice of window dressing. (See income smoothing and window dressing.)
net income: Equals sales revenue and other income less all expenses and losses for the period; also, any extraordinary gains and losses for the period are counted in the calculation to get to bottom-line net income. Bottom line means everything has been deducted from sales revenue (and other income the business may have) so the last profit line in the income statement is the final amount of profit for the period. Instead of net income, you may see terms such as net earnings, earnings from operations, or just earnings. You do not see the term profit very often.
operating activities: Generally this term refers to the profit-making activities of a business — that is, the mainstream sales and expense transactions of a business. In the statement of cash flows this term refers to one of the three classes of cash flows reported in this financial statement (the other two being investing and financing activities).
operating liabilities: Refers to the liabilities from making purchases on credit for items and services needed in the normal, ongoing operating activities of a business. The term also includes the liabilities that are recorded to recognize the accumulation or accrual of unpaid expenses in order to record the full costs of expenses for the period. (An example is accumulated vacation pay earned by employees that will not be taken until later).
owners’ equity: The ownership capital base of a business. Owners’ equity derives from two sources: investment of capital in the business by the owners (for which capital stock shares are issued by a corporation) and profit that has been earned by the business but has not been distributed to its owners (called retained earnings for a corporation).
pass-through tax entity: A type of legal organization that does not itself pay income tax but instead serves as a conduit of its annual taxable income to its owners. The business passes through its annual taxable income to its owners, who include their respective shares of the amount in their individual income tax returns. Partnerships are pass-through tax entities by their very nature. Limited liability companies (LLCs) and certain corporations (called S corporations) can elect to be treated as pass-through tax entities.
preferred stock: A second type, or class, of capital stock that is issued by a business corporation in addition to its common stock. Preferred stock has certain preferences over the common stock: It is paid cash dividends before dividends can be paid to common stockholders; and, in the event of liquidating the business, preferred stock shares must be redeemed before any money is returned to the common stockholders. Owners of preferred stock usually do not have voting rights, and the stock may be callable by the corporation, which means that the business has the right to redeem the shares for a certain price per share.
prepaid expenses: Expenses that have been paid in advance, or up front, for future benefits. The amount of cash outlay is entered in the prepaid expenses asset account. For example, a business writes a $60,000 check today for fire insurance coverage over the following six months. The total cost is first entered in the prepaid expenses asset account; then each month $10,000 is taken out of the asset and charged to expense. Prepaid expenses are usually smaller than a business’s inventory, accounts receivable, and cash assets.
price/earnings (P/E) ratio: The current market price of a capital stock divided by its trailing 12 months’ diluted earnings per share (EPS) — or its basic earnings per share if the business does not report diluted EPS.
product cost: Equals the purchase cost of goods that are bought and then resold by retailers and wholesalers (distributors). In contrast, a manufacturer combines different types of production costs to determine product cost: direct (raw) materials, direct labor, and overhead costs.
profit: A very general term that is used with different meanings. It may mean gains minus losses, or other kinds of increases minus decreases. In business, the term means sales revenue (and other sources of income) minus expenses (and losses) for a period of time, such as one year. In an income statement the preferred term for final or bottom-line profit is net income. For public companies, net income is put on a per-share basis, called earnings per share.
profit and loss (P&L) report: A popular title for internal profit performance reports to managers (which are not circulated outside the company). The term has a certain ring to it that sounds good, but if you consider it closely, how can a business have profit and loss at the same time?
property, plant, and equipment: The term generally used in balance sheets instead of fixed assets. (See fixed assets.)
proxy statement: The annual solicitation from a corporation’s top executives and board of directors to its stockholders that requests that they vote a certain way on matters that have to be put to a vote at the annual meeting of stockholders. In larger public corporations, most stockholders cannot attend the meeting in person, so they delegate a proxy (stand-in person) to vote their shares yes or no on each proposal on the agenda.
Public Company Accounting Oversight Board (PCAOB): The regulatory agency of the U.S. federal government created by the Sarbanes-Oxley Act of 2002, which was enacted in response to fallout from a number of high-profile accounting fraud scandals that the CPA auditors of the businesses failed to discover. This board has broad powers over the auditors of public businesses.
quality of earnings: Generally used as cautionary term that raises questions about the net income reported by a business. The issue at hand is whether the accounting methods of a business are correct in the circumstances, and it raises the possibility that reported profit should not be relied on, or at least taken with a grain of salt.
quick ratio: Calculated by dividing the total of cash, accounts receivable, and marketable securities (if any) by total current liabilities. This ratio measures the capability of a business to pay off its current short-term liabilities with its cash and near-cash assets. Note that inventory and prepaid expenses, two other current assets, are excluded from assets in this ratio (which is also called the acid-test ratio).
retained earnings: One of two basic sources of the owners’ equity of a business (the other being capital invested by the owners). Annual profit (net income) increases this account, and distributions from profit to owners decrease the account. The balance in the retained earnings account does not refer to cash or any particular asset.
return on assets (ROA): Equals profit divided by total assets and is expressed as a percent. Caution: There is not just one standard way of calculating this ratio. Different definitions of profit and total assets are used for different purposes. The general purpose for calculating ROA is to test whether a business is making good use of its assets, particularly relative to its cost of capital rate.
return on equity (ROE): Equals net income (minus preferred stock dividends if any) divided by the book value of owners’ equity (minus the amount of preferred stock) and is expressed as a percent. ROE is a basic measure of how well (or poorly) a business is doing in generating earnings relative to the amount of owners’ capital.
return on investment (ROI): In the field of finance this is a very broad and general term that refers to the income, profit, gain, or earnings for a period of time on the capital investment during that period, expressed as a percentage of the amount invested. Two relevant ROI ratios for a business are return on assets (ROA) and return on equity (ROE).
Securities and Exchange Commission (SEC): The federal agency that has jurisdiction and broad powers over the public issuance and trading of securities (stocks and bonds). Although it has the power to legislate accounting standards, the SEC has largely deferred to the Financial Accounting Standards Board (FASB). The Public Company Accounting Oversight Board (PCAOB) is a quasi-autonomous branch of the SEC.
solvency: Refers to the ability of a business (or other entity) to pay its liabilities on time. The current ratio and quick ratio are used to assess the short-term solvency of a business.
statement of cash flows: One of the three primary financial statements of a business, which summarizes its cash inflows and outflows during a period according to a threefold classification: cash flow from operating activities, investing activities, and financing activities.
statement of changes in owners’ (stockholders’) equity: A supplementary statement (or schedule, if you prefer) to the three primary financial statements. Its purpose is to summarize changes in the owners’ equity accounts during the year, including distributing cash dividends, issuing additional stock shares, and buying some of its own capital stock shares. Also, this statement reports changes in the accumulated other comprehensive income account, in which certain types of technical gains and losses are recorded that are not reported in the income statement.
variable costs: Costs that are sensitive to and vary with changes in sales volume or sales revenue. In contrast, fixed costs do not change over the short run in response to changes in sales activity.
window dressing: An accounting ruse that makes the liquidity and short-term solvency of a business look better than it really was on the balance sheet date. The books are held open a few business days after the close of the accounting year in order to record additional cash receipts (as if the cash collections had occurred on the last day of the year). This term generally does not refer to manipulating the timing for recording profit — which is called income smoothing). Tip: A reasonable amount of window dressing is not viewed as accounting fraud, but rather as “fluffing the pillows” (as my late father-in-law and businessman liked to put it).