Glossary

ABC system of inventory control A method of applyingdifferent levels of inventory control based on the value ofeach category of inventory. (p. 455)

Accounting rate of return (ARR) The average profit froman investment, expressed as a percentage of the averageinvestment made. (p. 183)

Accounts receivable factoring A service offered by a finan-cial institution known as a factor. The factor takes overthe accounts receivable collection for a business and mayoffer to undertake credit investigations and advise on thecreditworthiness of customers. It may also offer protec-tion for approved credit sales. (p. 293)

Acid test ratio A liquidity ratio that relates the current assets(minus inventory) to the current liabilities. (p. 115)

Acquisition A term normally used to describe a situation wherea larger business acquires control of a smaller business,which is then absorbed by the larger business. (p. 529)

Agency problem The conflict of interest between the share-holders (the principals) and the managers (agents) of abusiness, which arises when the managers seek tomaximize their own welfare. (p. 13)

Aging schedule of receivables A report dividing receivablesinto categories, depending on the length of time out-standing. (p. 466)

Amortization The apportionment of the cost of a long-term capital asset to the income statement as an expense.(p. 35)

Angel investors Wealthy individuals willing to invest in busi-nesses at an early stage in their development. (p. 350)

Annuity An investment that pays a constant sum each yearover a period of time. (pp. 159, 231)

Annuity due A stream of equal cash flow amounts with thefirst payment starting immediately. (p. 160)

Arbitrage transaction A transaction that exploits differ-ences in price between similar shares (or other assets)and which involves selling the overpriced shares andpurchasing the underpriced shares. (p. 406)

Asset Anything the company owns that is expected toprovide future benefits. (p. 22)

Asset-based financing A form of financing where assets areused as security for cash advances to a business. Factoringand invoice discounting, where the security is accountsreceivable, are examples of asset-based financing. (p. 297)

Average collection period for receivables The average timetaken by a business to collect its receivables. (pp. 107, 466)

Average inventory turnover period An efficiency ratio thatmeasures the average period during which inventory isheld by a business. (p. 106)

Average payment period for payables The average time takenby a business to pay the amounts owing to its creditors.(pp. 107, 478)

Balance sheet Shows the financial position (assets, liabilities,and shareholders’ equity) of the company at one point intime. (p. 30)

Balance sheet (net book value) method A method of valu-ing the shares of a business by reference to the value ofthe net assets as shown in the balance sheet. (p. 553)

Bank overdraft An amount owing to a bank that isrepayable on demand. The amount borrowed and therate of interest may fluctuate over time. (p. 293)

Behavioural finance An approach to finance that rejectsthe notion that investors behave in a rational mannerand, instead, make systematic errors when processinginformation. (p. 332)

Best efforts deal A method of selling shares to the publicthrough the use of an issuing house, which acts asan intermediary, but which does not, itself, purchaseshares. (p. 339)

Beta A measure of the extent to which the returns on a particu-lar share vary compared to the market as a whole. (p. 372)

Bond discount The difference between the bond’s face valueand its fair value when the market interest rate is greaterthan the bond’s coupon rate. (p. 166)

Bond premium The difference between the bond’s fair valueand its face value when the market interest rate is lowerthan the bond’s coupon rate. (p. 166)

Bought deal When a listed business sells a new issue ofshares to a financial institution known as an investmentdealer, which, in turn, sells the shares to the public. Theinvestment dealer will publish a prospectus describingdetails of the business and the type of shares to be sold,and investors will be invited to apply to purchase shares.(p. 339)

Capital asset pricing model (CAPM) A method of estab-lishing the cost of share capital that identifies two formsof risk: diversifiable risk and non-diversifiable risk.(p. 371)

Capital cost allowance (CCA) The tax return’s equivalent toamortization expense. (p. 35)

Capital markets Financial markets for long-term loans,bonds and debentures, and shares. (p. 4)

Capital rationing Limiting the long-term funds available forinvestment during a period. Soft capital rationing isimposed by managers; hard capital rationing is imposedby investors. (p. 210)

Cash discount A reduction in the amount due for goods orservices sold on credit in return for prompt payment.(p. 465)

Cash flow statement Measures the sources (cash inflows)and uses (cash outflows) of cash for the companythroughout a period. (p. 31)

Clientele effect The phenomenon where investors seek outbusinesses whose dividend policies match their particularneeds. (p. 431)

Coefficient of correlation A statistical measure of associa-tion that can be used to measure the degree to which thereturns from two separate projects are related. Themeasure ranges from �1 to –1. A measure of �1 indicates

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a perfect positive correlation and a measure of –1indicates a perfect negative correlation. (p. 259)

Competition Act Canadian legislation governing mergers thatcould affect competition in Canada, which could block all orpart of the merger. In the case where some of the mergeris blocked, the ruling would allow the merger to proceed ifthe parties sell certain specified assets. Areas considered indetermining the effect a merger would have on competitioninclude the degree of concentration within an industry,barriers to entry in the industry, and the remaining effectivecompetition in the industry. (p. 548)

Competitor profiling Building a profile of the strengths andweaknesses of a major competitor in order to understandthe threats posed. (p. 52)

Compounding Computing interest on the principal andaccrued interest, usually to arrive at a future value amount.(p. 157)

Compound interest A situation where the interest aninvestment earned last year also earns interest this year,resulting in interest on interest. (p. 157)

Conglomerate merger A merger between two businessesengaged in unrelated activities. (p. 530)

Convertible bond A bond that can be converted into com-mon shares at the option of the bond holders. (pp. 283)

Corporate governance Systems for directing and control-ling a business. (p. 12)

Cost of capital The rate of return required by investorsin the business. The cost of capital is used as the criterion rateof return when evaluating investment proposals using theNPV and IRR methods of appraisal. (pp. 192, 347)

Coupon rate The rate of interest that a bond pays is itscoupon rate (p. 163)

Creative accounting Adopting accounting policies toachieve a particular view of performance and positionthat preparers would like users to see rather than what isa true and fair view. (p. 135)

Credit note A written agreement requiring one party to theagreement to pay (Notes payable) a particular amount atsome future date to the other party to the agreement(Notes receivable). (p. 293)

Crown jewels The most valued part of a business (whichmay be sold to fend off a hostile takeover bid). (p. 547)

Cum dividend A term used to describe the price of a sharethat includes the right to receive a forthcoming dividend.(p. 421)

Current ratio A liquidity ratio that relates the current assetsof the business to the current liabilities. (p. 114)

Debenture A bond that does not pledge specific assets assecurity for the loan is called a debenture (pp. 163, 279)

Degree of financial leverage A measure of the sensitivity ofearnings per share to changes in earnings before interestand taxes (EBIT). (p. 389)

Discounting The act of computing the present value ofamounts to be received in the future. (p. 158)

Discount rate The interest rate used to discount future cashflows back to the present to determine their presentvalue. (p. 158)

Diversifiable risk The part of the total risk that is specific to aninvestment and which can be diversified away through com-bining the investment with other investments. (p. 261)

Diversification The process of reducing risk by investing ina variety of different projects or assets. (p. 258)

Divestment A selling-off of business operations undertakenfor various reasons including financial problems, defen-sive tactics, strategic focus, and poor performance.(p. 548)

Dividend A transfer of assets (usually cash payment) made bya business to its owners, the shareholders. (pp. 23, 420)

Dividend cover ratio An investment ratio that divides thenet income available to common shareholders by theannual dividends to common shareholders; the recipro-cal of the dividend payout ratio. (pp. 120, 422)

Dividend payout ratio An investment ratio that divides thedividends announced for the period by the profit generatedduring the period and available for dividends. (p. 119)

Dividend per share An investment ratio that divides thedividends announced for a period by the number ofshares in issue. (p. 120)

Dividend valuation method Uses the company’s dividend,dividend growth rate, and return required by its investors tocalculate the market value of one of the company’s shares.(p. 557)

Dividend yield ratio An investment ratio that relates thecash return from a share to its current market value.(pp. 120, 556)

Earnings per share (EPS) An investment ratio that dividesthe earnings (profits) generated by a business, and avail-able to common shareholders, by the number of shares inissue. (p. 121)

EBIT–EPS indifference chart A chart that plots the returns toshareholders at different levels of earnings before interestand taxes for different financing options. (p. 396)

Economic order quantity (EOQ) The quantity of inventorythat should be purchased in order to minimize totalinventory costs. (p. 456)

Economic value added (EVA) The difference between thenet operating profit after tax and the required returnsfrom investors. (p. 501)

Efficient stock market A stock market where new informationis quickly and accurately absorbed by investors, resulting inan appropriate share price adjustment. (p. 321)

Equivalent-annual-annuity approach An approach todeciding among competing investment projects withunequal lives that involves converting the NPV of eachproject into an annual annuity stream over the project’sexpected life. (p. 232)

Eurobonds Bearer bonds that are issued by listed businessesand other organizations in various countries with thefunds being raised on an international basis. (p. 281)

Event tree diagram A diagram that portrays the variousevents or outcomes associated with a particular course ofaction and the probabilities associated with each event oroutcome. (p. 250)

Ex dividend A term used to describe the price of a share thatexcludes any right to a forthcoming dividend. (p. 421)

Expected net present value (ENPV) A method of dealingwith risk that involves assigning a probability of occur-rence to each possible outcome. The expected net presentvalue of the project represents a weighted average of thepossible net present values where the probabilities areused as weights. (p. 248)

Expected value A weighted average of a range of possibleoutcomes where the probabilities are used as weights.(p. 247)

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Expected value–standard deviation rules Decision rulesthat can be employed to discriminate among competinginvestments where the possible outcomes are known andare normally distributed. (p. 257)

Expenses May be viewed as assets that were used up duringthe accounting period. (p. 23)

Financial derivative Any form of financial instrument,based on shares or bonds, that can be used by investorseither to increase their returns or to decrease their expo-sure to risk. (p. 275)

Financial leverage The existence of fixed-payment-bearingsecurities (for example, loans) in the capital structure ofa business. (p. 116)

Five Cs of credit A checklist of factors to be taken intoaccount when assessing the creditworthiness of acustomer. (p. 460)

Fixed charge Where a specific asset is offered as security fora loan or debenture. (p. 278)

Fixed costs Costs that stay the same even though the level ofoutput changes. (p. 53)

Fixed interest rate A rate of return payable to lenders thatwill remain unchanged despite rises and falls in marketinterest rates. (p. 288)

Floating charge Where the whole of the assets of the busi-ness is offered as security for a loan or debenture. Thecharge will crystallize and fix on specific assets in theevent of a default in loan obligations. (p. 278)

Floating interest rate A rate of return payable to lenders thatwill rise and fall with market rates of interest. (p. 288)

Free cash flow method Uses the present value of company’sfree cash flows less market value of its outstanding debtdividend by the number of its outstanding shares tocalculate the market value of one share in the company.(p. 557)

Free cash flows Cash flows available to long-term lenders andshareholders after any new investment in assets. (p. 495)

Future growth value (FGV) Value placed on the futuregrowth potential of a business by investors. (p. 520)

Future value (FV) The value of an amount of money investedtoday at some time in the future. (p. 157)

Golden parachute Substantial fee payable to a manager of abusiness in the event the business is taken over. (p. 547)

Gross profit margin ratio A profitability ratio relating the grossprofit for the period to the sales for that period. (p. 103)

Hedging arrangement An attempt to reduce or eliminatethe risk associated with a particular action by takingsome form of counteraction. (p. 288)

High-yield bonds. See junk bonds. (p. 285)Horizontal merger A merger between two businesses in

the same industry and at the same point in theproduction/distribution chain. (p. 530)

Income statement Measures revenues minus expenses, whichequals the amount of earnings (profit or loss) the companyhas incurred during the period. (p. 28)

Indifference point The level of profit and interest beforetaxes at which two, or more, financing plans provide thesame level of return to common shareholders. (p. 396)

Inflation A general rise in the price for goods and services.(p. 156)

Information asymmetry Where the availability of infor-mation differs between groups (such as managers andshareholders). (p. 432)

Information signalling Conveying information to share-holders through management actions (for example,increasing dividends to convey management optimismconcerning the future). (p. 432)

Interest rate swap An arrangement between two businesseswhereby each business assumes responsibility for theother’s interest payments. (p. 288)

Internal rate of return (IRR) The discount rate for a projectthat has the effect of producing zero NPV. (p. 193)

Interpolation A technique involving the prorating ofpresent value or future value factors. (p. 195)

Junk bonds Bonds with a relatively high level of investmentrisk for which investors are compensated by relatively highlevels of return. Also called high yield bonds. (p. 285)

Just-in-time (JIT) inventory management A system of inven-tory management that aims to have supplies delivered toproduction just in time for their required use. (p. 458)

Lead time The time lag between placing an order for goodsor services and their delivery. (p. 454)

Lease An arrangement in which a business does not buy anasset directly from a supplier but instead has anotherbusiness (usually a bank) buy it and then allow the busi-ness exclusive use of the asset for a specific time in returnfor payment. (p. 289)

Leverage ratio A ratio that relates the contribution of long-term lenders to the total long-term capital of the business.(p. 117)

Liability An amount that the business owes. (p. 22)Linear programming A mathematical technique for

rationing limited resources in such a way as to optimizethe benefits. (p. 228)

Liquidation method A method of valuing the shares of abusiness by reference to the net realizable values of its netassets. (p. 554)

Loan covenants Obligations, or restrictions, on the businessthat form part of the loan contract. (p. 278)

Market capitalization The total market value of the sharesof a business. (p. 316)

Market value added (MVA) The difference between themarket value of the business and the total investment thathas been made in it. (p. 512)

Matching principle Expenses in a period are matchedto the revenues that were generated in the same period.(p. 24)

Materials requirement planning (MRP) system A computer-based system of inventory control that schedules thetiming of deliveries of brought-in parts and materials tocoincide with production requirements to meet demand.(p. 458)

Merger When two or more businesses combine in order toform a single business. (p. 529)

Mission statement A statement setting out the purpose forwhich a business exists. (p. 8)

Mixed costs Costs that have an element of both fixed andvariable costs. (p. 53)

Mortgage A loan secured on property. (p. 280)Net present value (NPV) The net cash flows from a project

that have been adjusted to take account of the time valueof money. The NPV measure is used to evaluate invest-ment projects. (p. 191)

Net realizable value The selling price of an asset, minus anycosts incurred in selling the asset. (p. 554)

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Non-diversifiable risk The part of the total risk that is com-mon to all investments and which cannot be diversifiedaway by combining investments. (p. 262)

Normal distribution The description applied to the distri-bution of a set of data which, when displayed graphically,forms a symmetrical bell-shaped curve. (p. 256)

Objective probabilities Probabilities based on informationgathered from past experience. (p. 257)

Operating cash cycle (OCC) The time period between theoutlay of cash to purchase goods supplied and the ulti-mate receipt of cash from the sale of those goods.(p. 472)

Operating lease A short-term lease where the rewards andrisks of ownership stay with the owner. (p. 290)

Operating profit margin ratio A profitability ratio relating theearnings before interest and taxes (EBIT) for the periodto the sales for that period. (p. 102)

Opportunity cost The monetary value of being deprived ofthe next best opportunity in order to pursue the particu-lar objective. (p. 201)

Optimal capital structure The particular mix of long-termfunds employed by a business that minimizes the cost ofcapital. (p. 402)

Ordinary annuity A stream of equal cash flows with the firstpayment starting one period from now. (p. 159)

Overtrading The situation arising when a business is oper-ating at a level of activity that cannot be supported bythe amount of financing that has been committed.(p. 128)

Pac-man defence A means of defending against a hostiletakeover bid that involves launching a bid for the biddingcompany. (p. 547)

Payback period (PP) The time taken for the initial invest-ment in a project to be repaid from the net cash inflowsof the project. (p. 188)

Percent-of-sales method A method of financial planningthat first estimates the sales for the planning period andthen estimates other financial variables as a percentage ofthe sales figure. (p. 72)

Poison pill A defensive measure taken by a business that isdesigned to make it unattractive to potential acquirers.(p. 547)

Post-completion audit A review of the performance of aninvestment project to see whether actual performancematched planned performance and whether any lessonscan be drawn from the way in which the investment wascarried out. (p. 213)

Present value (PV) The value today of an amount of moneyto be received at some time in the future. (p. 158)

Price/earnings (P/E) ratio An investment ratio that relatesthe market value of a share to the earnings per share.(pp. 122, 555)

Private placement Does not involve an invitation to thepublic to subscribe to shares; instead, the shares areplaced with selected investors, such as large financialinstitutions. (p. 341)

Pro forma financial statements Financial statements suchas the cash flow statement, income statement, statementof retained earnings, and balance sheet that have beenprepared on the basis of estimates and which relate to thefuture. (p. 48)

Profitability index The present value of the future cashflows from a project divided by the present value of theoutlay. (p. 227)

Receivables discounting When a business approaches afactor or other financial institution for a loan based on aproportion (usually 75–80%) of the face value ofaccounts receivable outstanding. The business must agreeto repay the advance within a relatively short period—perhaps 60 or 90 days. The responsibility for collectingthe accounts receivable outstanding remains with thebusiness and repayment of the advance is not dependenton the receivables being collected. (p. 296)

Record date A date that is set by the directors of a business toestablish who is eligible to receive dividends. Those share-holders registered with the company on this date willreceive any dividends announced for the period. (p. 421)

Relevant costs Costs that are relevant to a particulardecision. (p. 200)

Replacement cost The cost of replacing an asset with anidentical asset. (p. 554)

Return on capital employed (ROCE) A profitability ratioexpressing the relationship between the earnings (beforeinterest and taxes) for the period and the long-termcapital invested in the business. (p. 101)

Return on equity (ROE) A profitability ratio expressing therelationship between the profit available for commonshareholders for the period and the common sharehold-ers’ funds invested in the business. (p. 100)

Revenues Include sales of the company’s goods and feescharged for services performed. (p. 23)

Rights issue An offer to existing shareholders allowing them tobuy shares at a price usually below market value. (p. 234)

Risk The likelihood that what is estimated to occur will notactually occur. (pp. 77, 155, 235)

Risk-adjusted discount rate A method of dealing with riskthat involves adjusting the discount rate for projectsaccording to the level of risk involved. The risk-adjusteddiscount rate will be the risk-free rate plus an appropri-ate risk premium. (p. 246)

Risk-averse investors Investors who select the investmentwith the lowest risk where the returns from differentinvestments are equal. (p. 243)

Risk-neutral investors Investors who are indifferent to thelevel of risk associated with different investments.(p. 243)

Risk premium An extra amount of return from an investment,owing to a perceived level of risk: the greater the perceivedlevel of risk, the larger the risk premium. (p. 156)

Risk-seeking investors Investors who select the investmentwith the highest risk where the returns from differentinvestments are equal. (p. 243)

Sale-and-leaseback arrangement An agreement to sell anasset (usually property) to another party and simultane-ously lease the asset back in order to continue using theasset. (p. 291)

Sales revenue per employee An efficiency ratio that relatesthe sales generated during a period to the averagenumber of employees of the business. (p. 109)

Sales revenue to capital employed An efficiency ratio thatrelates the sales generated during a period to the long-term capital employed. (p. 108)

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Satisficing The idea that managers should try to provideeach stakeholder group of the business with a satisfactorylevel of return. (p. 8)

Scenario analysis A method of dealing with risk thatinvolves changing a number of variables simultaneouslyso as to provide a particular scenario for managers toconsider. (pp. 77, 241)

Securitization Bundling together illiquid financial or physicalassets of the same type in order to provide backing forissuing interest-bearing securities, such as bonds. (p. 291)

Security An asset pledged or a guarantee provided against aloan. (p. 278)

Sensitivity analysis An examination of the key variablesaffecting a project to see how changes in each variablemight influence the outcome. (pp. 77, 236)

Shareholders’ equity Includes contributed capital andretained earnings. (p. 22)

Shareholder value Putting the needs of shareholders at theheart of management decisions. (p. 491)

Shareholder value analysis (SVA) A method of measuringand managing business value based on the long-termcash flows generated. (p. 494)

Shareholder wealth maximization The idea that the mainpurpose of a business is to maximize the wealth of itsowners (shareholders). This idea underpins modernfinancial management. (p. 5)

Share options A plan that allows managers and employeesto acquire shares in the business at some future date onfavourable terms. (p. 13)

Shortest-common-period-of-time approach A method ofcomparing the profitability of projects with unequal livesthat establishes the shortest common period of time overwhich the projects can be compared. (p. 230)

Simple interest A simple interest investment earns interestonly on the initial investment. (p. 157)

Simulation A method of dealing with risk that involves calcu-lating probability distributions from a range of possibleoutcomes. (pp. 78, 242)

Spin-off The transfer of part of the assets in an existingbusiness to a new business. Shareholders in the existingbusiness will be given shares, usually on a pro rata basis,in the new business. (p. 549)

Standard deviation A measure of spread that is based ondeviations from the mean or expected value. (p. 254)

Statement of retained earnings Measures the changes inretained earnings from one period to the next. (p. 29)

Stock dividend A dividend to shareholders consisting ofadditional shares rather than cash; transfer of retainedearnings to common share capital requiring the issue ofnew shares to shareholders in proportion to existingshareholdings. (pp. 337, 441)

Stock exchange A primary and secondary market for busi-ness capital. (p. 313)

Strip bonds Redeemable bonds that are issued at a zero rateof interest and at a large discount to their redeemable

value. Also called zero-coupon bonds, as the interestcoupons have been stripped away. (p. 282)

Subjective probabilities Probabilities based on opinionrather than past data. (p. 257)

Subordinated loan A loan that is ranked below other loancapital in order of interest payment and capital repay-ment. (p. 280)

Synergy The whole is bigger than the sum of the parts;2 � 2 � 5. (p. 531)

Tender issue An issue of shares to investors that requires theinvestors to state the amount that they are prepared topay for the shares. (p. 339)

Term loan A loan, usually from a bank, that is tailoredspecifically to the needs of the borrower. The loan con-tract usually specifies the repayment date, interest rate,and so on. (p. 279)

Times interest earned ratio A leverage ratio that divides theoperating profit before interest and taxes by the interestexpense for a period. (p. 117)

Total shareholder return (TSR) The change in share valueover a period plus any dividends paid during the period.(p. 516)

Utility function A chart that portrays the level of satisfactionor pleasure obtained from receiving additional wealth atdifferent levels of existing wealth. (p. 243)

Value drivers Key variables that determine business per-formance. (p. 497)

Variable costs Costs that vary according to the volume ofactivity. (p. 53)

Venture capital Long-term capital provided by certain insti-tutions to small and medium-sized businesses to exploitrelatively high-risk opportunities. (p. 342)

Vertical merger A merger between a supplier of goods orservices and its customer. (p. 530)

Warrant A document giving the holder the right, but not theobligation, to acquire shares in a business at an agreedprice at some future date. (p. 275)

Weighted average cost of capital (WACC) A weighted aver-age of the post-tax costs of the forms of long-termfinancing employed within a business where the marketvalues of the particular forms of financing are used asweights. (p. 381)

White knight A potential bidder for a business that isapproached by the managers of that business to make abid. The approach is made to defend the business againsta hostile bid from another business. (p. 547)

White squire A company (or individual investor) that isapproached by the managers of another business topurchase a large block of shares in the business withthe object of rescuing it from a hostile takeover.(p. 547)

Working capital Current assets less current liabilities.(pp. 23, 448)

Zero coupon bonds Loans that carry a zero rate of interest.(p. 282)

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