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April 25, 2006
Finance Terms Made Simple
Human Resources may at
times find itself at odds with Finance when
seeking approval for proposals. While both
groups, hopefully, have the organization's best
interests in mind, different approaches and
terminologies underscore the differences that
often exist between these two departments. In
this Astronology, we present a glossary
of terms useful when seeking the buy-in of CFOs
and Finance Departments.
ROI: Return on Investment. This refers to
how much profit or cost saving is realized in a
given period of time - usually a year - as the
result of a particular expenditure. Human
resources professionals who are sometimes
accused of presenting "touchy-feely" rationales
for monetary expenditures can use ROI
calculations to help develop the financial case
for a proposal in a way an organization's
financial staff can readily understand. For
example, what are the costs incurred in
developing a new training program? What will
the monetary benefits of that training be?
While useful from an accounting point of view,
the following five terms are also critical for
designing and administering sales compensation
plans:
Revenue: The total influx of funds into
an organization, usually resulting from the
sales of goods or services, calculated before
costs or expenses are deducted. This figure
includes all sales made to customers / clients
in addition to other income arising from
business operations.
Expenses: All costs deductible from
revenues.
Gross margin: Sales revenue minus the
cost of the goods sold. This term is often used
as a performance measure.
Net income: Revenue minus expenses,
including maintenance, taxes, and losses. This
term is synonymous with the terms net earnings,
net profit, and bottom line.
Profit margin: The percentage of total
revenues that net income represents. This term
is often mistakenly used as a synonym for net
income or profit. If total revenue for a given
period is $12,000, and expenses are $10,000, the
net income would be $2,000, while the profit
margin would be 16.67%. Acceptable profit
margins vary widely by industry.
Value added: The sales price of goods or
services minus the cost of any raw materials or
inputs purchased elsewhere. Success is often
measured by how much value an organization can
add to its goods or services.
ROA: Return on assets; the ratio of net
earnings to total assets. Sometimes used as a
measurement in executive incentive compensation
plans.
Asset: Anything owned by an organization
or an individual with commercial or exchange
value, including claims against others.
Accounts receivable, product inventory, and
buildings owned by the company are examples of
assets. In accounting and finance, employees or
an organization’s brand are not assets. Often
contrasted with liability.
Liability: Debt or responsibilities owed
by an organization that must be paid in the
future. Examples of liabilities are accounts
payable, bonds payable, and taxes payable.
Deferral of taxes: Postponement of taxes
to a later payment period, often by recognizing
income or gain at a later time, such as through
qualified retirement plans (e.g., 401(k) or
403(b) plans).
Tax incentives: Benefits that reduce
pre-tax income, resulting in less tax paid by
both employer and employee. New York City's
TransitChek program is one example.
Earning per share: An organization's net
income divided by total shares outstanding,
adjusted for common stock equivalents. This is
often used as the measurement in executive
incentive compensation programs.
Balance sheet: A detailed statement of an
organization's finances, showing assets,
liabilities, and net worth. The balance sheet
follows the formula assets = liabilities + net
worth. Net worth can be comprised of owner's
equity and retained earnings. The balance sheet
describes the financial well being of an
organization on a given date.
Income statement: A financial statement
including revenues and expenses incurred during
a particular period of time, such as a fiscal
year. The business equivalent of your personal
checkbook.
Present value: The current value of a
cash payment, good, or service, discounted at an
appropriate interest rate. By the logic of
present value, $5 received five years from now
is worth less than $5 received today. Using
present-value formulae, assumptions about future
interest rates are applied to produce estimates
of the current worth of a dollar delivered at
some specific point in the future. Such formulae
are useful in determining ROI for proposed
initiatives.
Days in Receivables: Average collection
period, or how long it takes an organization to
collect on invoices sent out for work performed
/ goods sold. The longer the average collection
period, the greater the potential negative
impact on cash flow.
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Copyright 2007, Astron Solutions, LLC
ISSN Number 1549-0467
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