Key Financial Terms

The key to understanding your balance sheet and financial terms it understanding terms used within in the Balance Sheet and by your accountant to describe your financial condition. The following are definitions of many of those terms.

Current Asset: A current asset is an asset that will be used in one year or business cycle such as cash and inventory.

Current Liability: A current liability is a liability that will come due and is expected to be settled for cash within one year or business cycle such as accounts payable or lines of credit used

Fixed Asset:  A Fixed Liability or Long Term Asset is a liability that cannot be quickly converted to cash, is not sold to the public but is rather used by the company in the operations such as autos, buildings, machinery or equipment.  

Fixed Liability: A Fixed Liability is a debt that will not be retired within one year such as mortgage,

Current Ratio: Current Ratio is current assets/current liabilities. It is an indicator of the liquidity of a corporation and reflects on its ability to pay its bills. Generally banks and investors are looking for a current ratio of 2 but this can vary by industry. Companies with inventory that turns over quicker than payable become due can survive with lower ratio.

Working Capital: Working Capital is Current Assets – Current Liabilities.

Cash Flow: Cash flow is incoming cash less out going cash of a fixed period.

Return on Investment or Rate of Return:  Increase in value/initial investment.  In most small businesses calculating this from balance sheet will not tell the whole story.  Small business owners will likely take benefits from the company that reduce the current value but are the result of operating the company such as paycheck, bonuses, auto, life insurance, rent from personal assets rented to company and others.  It is good to calculate this number so you know that your money is working efficiently.  No sense in running your business and risking your investment for a 1% return.

Debit: A debt is an increase in an asset or a decrease in a liability. A credit is the opposite a decrease in an asset or an increase in a liability. Your accountant many have a long textbook definition but in nearly all cases it is easy as this.

Original Material (c) Thomas Robinson 2010