Financial analysis

Financial analysis: What is it?

Financial analysis can be defined as a process that evaluates businesses, budgets, projects, and entities for analysis purpose. This evaluation is done with the purpose of determining the suitability for investment by a business. Usually, the main purpose of financial analysis is to analyze the stability, solvency, liquidity, and profitability of a business.

The process of financial analysis is carried out by professionals who work by preparing reports with the help of ratios containing information from financial statements and other similar reports.

Goals and Objectives

The main objectives of financial analysis include:

  • Solvency

One of the most important goals of financial analysis is to assess the ability of a business to pay back its debts (Short term and Long term) to its creditors. The liquidity of a business entity is reflected in its balance sheet.

  • Profitability

Another goal of financial analysis aims at assessing the profitability of a firm. Here, profitability refers to a firm’s ability to earn income and sustain its growth in both long-term and short-term. Statement of comprehensive income is used to determine the profitability of a company. Income statement provides other information as well like details of sources of income and expenses.

  • Liquidity

In addition to the aforesaid goals and objectives, a financial analysis reports about the firm’s ability to sustain positive cash flow in addition to satisfying current debts. Just like the solvency of a firm, the liquidity of a business firm is also indicted by its balance sheet.

  • Stability

Stability implies the ability of a business firm to maintain its existence in the long run. However, this stability should not include significant losses during the conduct of this business. The process of assessing the stability of a firm through financial analysis involves the use of the balance sheet as well as the income statement. Besides, other non-financial and financial indicators also play a vital role in the process.

It is noteworthy that while preparing the financial analysis for a company, the analysts focus on the balance sheet, the cash flow statement, and the income statement. Besides, one important area involved in financial analysis is the extrapolating firm’s past performance into its future performance.


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Adjusted Present Value (APV)

The Adjusted Present Value (APV) can be delineated as the Net Present Value of a project, financed exclusively by equity, added to the Present Value (PV) of any financing benefits (the added effects of debt). 

Altman Z-Score

The Altman Z-Score is an analytical representation created by Edward Altman in the 1960s which involves a combination of five distinctive financial ratios used for determining the odds of bankruptcy amongst companies. Most commonly, a lower score reflects higher odds of bankruptcy.

Annual Equivalent Rate (AER)

Annual Equivalent Rate or AER is the rate of interest an investor gets for a fixed deposit for a year on a yearly basis. By definition, Annual Equivalent Rate or AER is a figure which shows what the interest rate on an account would be if interest was paid for a full year and compounded. The interest is calculated to determine the returns that a person can get by adding the interest payment to the amount originally deposited and the next interest payment will be established on the marginally higher account balance.

Annualized Rate

Annualized rate is a rate of return for a given period that is less than 1 year, but it is computed as if the rate were for a full year. It is essentially an estimated rate of annual return that is extrapolated mathematically. The annualized rate is calculated by multiplying the change in rate of return in one month by 12 (or one quarter by four) to get the rate for the year. Annualized rate of return is computed on a time-weighted basis.

Annuity

In finance theory, the term annuity is used to refer to a terminating stream of fixed payments over a particular time period. Most commonly, this usage is reflected in financial discussions, generally in connection with the valuation of the payments’ stream, also considering the time value of money concepts like interest rates and future value. The annuities can be exemplified as regular deposits to a savings account, monthly insurance payments, and monthly home mortgage payments.

Average Annual Growth Rate

Average annual growth rate refers to the average increase in an individual’s portfolio or investment value over a year’s period. The average annual growth rate can be evaluated for any kind of investment, but does not include any measure of the overall risk involved in the investment, as calculated by the volatility of its price.

Average Annual Return

The average annual return is defined as a percentage figure which is used while reporting the previous returns, like 3-, 5-, and 10-year average returns of a mutual fund. The average annual return is calculated net of a fund’s operating expense ratio.

Bad Debt

bad debt can be defined and explained as an amount which has been written off by the business as a loss and categorized as an expense for the debt owed to the business cannot be collected and all efforts made for the same have failed to collect the owed amount. 

Balance Sheet Analysis

Balance sheet analysis can be defined as an analysis of the assets, liabilities, and equity of a company. This analysis is conducted generally at set intervals of time, like annually or quarterly. The process of balance sheet analysis is used for deriving actual figures about the revenue, assets, and liabilities of the company.

Bankruptcy

Bankruptcy can be explained as a legal proceeding which involves a business or individual being unable to repay his outstanding debts. 

Book Value of Equity per Share (BVPS)

The book value of equity per share is a financial measure which indicates a per share estimation of the minimum value of an entity’s equity. Although the book value of equity per share is a factor that can be used by the investors to determine the value of stock, it presents only a limited value of the firm’s situation. In simple words, book value per equity share gives a snap shot of a firm’s present situation not including the future considerations of a firm.

Break-even Point

The break-even point is a point where total costs (expenses) and total sales (revenue) are equal.

Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model (CAPM) refers to a model that delineates the relationship between risk and expected return and what is used in the pricing of risky securities. 

Capital Budgeting

Capital budgeting refers to a process that involves a business to determine whether the projects, like investing in a long-term venture or building a new plant, are worth following. Many times, an eventual project’s lifetime cash inflows and outflows are evaluated so as to determine whether the generated returns congregate to a satisfactory target benchmark. Capital budgeting is also referred as “investment appraisal”.

Capital Employed

Generally, capital employed is presented as deducting the current liabilities from the current assets. It can be defined as equity plus loans which are subject to interest. To define it properly, capital employed can be expressed as the total amount of capital that has been utilized for acquisition of profits. It also refers to the value of all assets (fixed as well as working capital) employed in a business.

Capital Output Ratio

capital output ratio which is abbreviated as COR is related to be availability of natural resources in a country. It is used to measure the capital ratio that would be used for the production of some output over a certain period of time. The capital output ratio tends to increase if the capital available in a country is cheaper than the other inputs.

Cash Burn Rate

The rate at which a company utilizes its cash supply over a specific period of time is known as the cash burn rate. From its name, it is clear that it is used to measure the speed at which cash ends or is burnt in consumption. It is specially used in such situations where the cash flow of the business activities is negative rather than positive. It is meant for such businesses that have been started newly and because of this they have not managed to make much of the sales that could cover up the expenses.

Coefficient of Variation

The coefficient of variation (CV) refers to a statistical measure of the distribution of data points in a data series around the mean. It represents the ratio of the standard deviation to the mean. The coefficient of variation is a helpful statistic in comparing the degree of variation from one data series to the other, although the means are considerably different from each other.

Company Analysis

Company analysis is a process carried out by investors to evaluate securities, collecting info related to the company’s profile, products and services as well as profitability. It is also referred as ‘fundamental analysis.’ A company analysis incorporates basic info about the company, like the mission statement and apparition and the goals and values. During the process of company analysis, an investor also considers the company’s history, focusing on events which have contributed in shaping the company.

Compound Annual Growth Rate

The compound annual growth rate (CAGR) of a company refers to the growth rate of an investment, year after year, for a particular time period.

Compound Interest

Compound interest is the form of simple interest where interest is added to the principle. When this happens, the interest that is added to the principle also earns interest. This method of addition of interest to the principle is known as compounding.

Contribution Margin

Contribution Margin (CM) is the difference between sales revenue and variable costs. It is the measure of the profit margin that focuses on the proportion of sales revenue which is left after the deduction of variable costs associated with the product.

Cost of Debt

Cost of debt generally refers to the effective paid by a company on its debts. The cost of debt can be calculated in either before or after tax returns. However, the interest expense being deductible, the after tax cost is considered very often. Moreover, the cost of debt is one part of capital structure of the company and also includes the cost of equity.

Country Risk

Country risk is a collection of risks that are associated with investing in a foreign country instead of investing in the domestic market. The risks included are exchange rate risk, economic risk, political risk, and sovereign risk or transfer risk and by which there is a risk of capital being frozen for Government action. Each country has different type of country risk, some having higher risks would not encourage any type of foreign investments.

Credit Risk

Credit risk refers to the risk of loss of principal or loss of a pecuniary reward stemming from a borrower’s failure in repaying a loan or else wise meet a contractual debt. Credit risk arises every time a borrower is looking ahead to use future cash flows through the payment of a current obligation. The investors are rewarded for presuming credit risk through the way of interest payments from the issuer or borrower of a debt contract.

Credit Score

credit score refers to a statistically derived numeric expression which implicates the creditworthiness of a person. This credit score, as an indicator of the creditworthiness, is used by the lenders to access the chances of a person repaying his/her debts.

Currency Risk

Currency risk refers to a risk form arising from the changes price of one currency as compared to another currency. Whenever companies or investors possess assets or business operations across national boundaries, they experience currency risk if their positions are not prevaricated. Currency risk is also referred as exchange rate risk. Putting it simple, currency risk can be defined as the possibility that currency depreciation will show negative effect on the value of assets, investments, and their related interest and dividend payment streams, specifically those securities denominated in foreign currency.

Data Analysis Techniques for Fraud Detection

Data analysis techniques for fraud detection refer to the techniques that make use of statistical techniques and artificial intelligence to detect fraud in any company. Fraud is defined as an intentional act of an individual or more persons to deny another person or organization of something that is of value for their own gain. Every year, the number of fraud cases is increasing and the reason for this may be attributed to technological development.

Deferred Payment Annuity

An annuity is essentially a finance related contract, which permits the person who is buying it to pay on a lump-sum basis or make payments in series, in return for acquiring disbursements at regular intervals in future. Deferred Payment Annuity is a type of an annuity in which the payments that are received start somewhere in the future instead of starting at the time it is initiated.

Degree of Combined Leverage (DCL)

The Degree of Combined Leverage (DCL) is the leverage ratio that sums up the combined effect of the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL) has on the Earning per share or EPS given a particular change in shares. This ratio helps in ascertaining the best possible financial and operational leverage that is to be used in any firm or business.

Degree of Financial Leverage (DFL)

The degree of financial leverage (DFL) is the leverage ratio that sums up the effect of an amount of financial leverage on the earning per share of a company. The degree of financial leverage or DFL makes use of fixed cost to provide finance to the firm and also includes the expenses before interest and taxes. If the Degree of Financial Leverage is high, the Earnings Per Share or EPS would be more unpredictable while all other factors would remain the same.

Degree of Operating Leverage (DOL)

The Degree of Operating Leverage (DOL) is the leverage ratio that sums up the effect of an amount of operating leverage on the company’s earnings before interests and taxes (EBIT). Operating Leverage takes into account the proportion of fixed costs to variable costs in the operations of a business. If the degree of operating leverage is high, it means that the earnings before interest and taxes would be unpredictable for the company, even if all the other factors remain the same.

Discount Rate

In finance, the discount rate has different meanings, some important ones mentioned below...

Discounted Cash Flow

The discounted cash flow is a quantification method used to evaluate the attractiveness of an investment opportunity. The Discounted Cash Flow analysis involves the use of future free cash flow protrusions and discounts them so as to reach the present value, which is then used to calculate the potential for investment. 

Discounted dividend model (DDM)

The discounted dividend model (DDM) is a procedure for valuing a stock’s price by using expected dividends and discounting them back to present value. The underlying idea is that if the value obtained from the dividend discount model is greater than the value at which shares are being already traded, the stock is considered to be undervalued. Putting it simple, the discounted dividend model is one of the methods of evaluating a company based on the theory that a stock holds the value equal to the discounted sum of all the prospective dividend payments.

Diversification

Diversification strategies are made use of to expand the operations of the firm by adding different strategies to a business. The main aim of diversification in a company is to allow the company to establish itself apart from its current operations. There are two types of diversification strategies. Concentric diversification is when a new venture is strategically related to the existing lines of business, and Conglomerate diversification is when there is nothing common between old and new business strategies, that is both the businesses are not related in anyway.

Due Diligence

The term “due diligence” is, generally used for various concepts involving investigation of either a person or business before signing a contract, or an act involving certain standards of care.

Economic Order Quantity Model (EOQ)

As the name suggests, Economic order quantity (EOQ) model is the method that provides the company with an order quantity. This order quantity figure is where the record holding costs and ordering costs are minimized. By using this model, the companies can minimize the costs associated with the ordering and inventory holding. In 1913, Ford W. Harris developed this formula whereas R. H. Wilson is given credit for the application and in-depth analysis on this model.

Economic Risk

Generally speaking, economic risk can be described as the likelihood that an investment will be affected by macroeconomic conditions such as government regulation, exchange rates, or political stability, most commonly one in a foreign country. In other words, while financing a project, the risk that the output of the project will not produce adequate revenues for covering operating costs and repaying the debt obligations.

Elasticity of Demand

Elasticity of demand refers to the degree of responsiveness to change in the demand of a product or services and its price.

Explicit Cost

Explicit cost is defined as the direct payment which is supposed to be made to others during the due course of running business. This includes the wages, rents or materials which are due in the contract.

Factor Analysis

Factor analysis is to reduce a set of variables to a set of new variables. It can be done through many methods and the variables are reduced to a set of lesser variables. In other words the process of making a reduced set of new and useful variables from a set of many variables is factor analysis

Financial Analysis Report

Comprehensive financial analysis reports accentuate the strengths and weaknesses of a company. Communicating the company’s strengths and weaknesses in an accurate and honest manner is helpful in convincing the investors to invest in your business. A financial analysis report is, basically, a document that attracts high interest of investors as it contains a detailed appraisal of a company’s financial health.

Financial Modeling

Financial modeling refers to the process through which a company builds up a financial representation of some, or even all aspects of the company or the given security. The financial model is generally featured by performing calculations, and making recommendations on the basis of that information. Moreover, the model might also précis specific events for the end user in addition to providing direction regarding possible alternatives or actions.

Financial Planning

Financial planning can be delineated as long-term profit planning intended at generating higher return on assets, growth in market share, and at solving foreseeable problems. Putting it simple, it is the process of estimating the amount of required capital and determining its competition. It is a process that frames financial policies in relation to investment, procurement, and administration of an enterprise’s funds.

Financial Ratio

financial ratio can be well defined as a comparative magnitude of two selected statistical values taken from the financial statements of a business enterprise.

Financial Responsibility

Financial responsibility refers to the process of managing money and other similar assets in a way that is considered productive and is also in the best interest of the individual, or the family, or the business company. Being adept at financial tasks and money management involves cultivation of a mindset which makes it possible to look beyond the needs of the present so as to provide for the needs of future. Besides, it is essentially important to understand the various basic principles so as to achieve a high level of financial responsibility.

Financial Statement Analysis

Financial statement analysis can be referred as a process of understanding the risk and profitability of a company by analyzing reported financial info, especially annual and quarterly reports. Putting another way, financial statement analysis is a study about accounting ratios among various items included in the balance sheet. These ratios include asset utilization ratios, profitability ratios, leverage ratios, liquidity ratios, and valuation ratios. Moreover, financial statement analysis is a quantifying method for determining the past, current, and prospective performance of a company.

Fixed Costs

Fixed costs, in economics, are explained as business expenses which do not depend on the level of goods and services proffered by a business. 

Fundamental Analysis

Fundamental analysis can be explained as a method of estimating a security which involves attempting to evaluate its basic value by assessing allied financial, economic, and other quantitative and qualitative factors. Fundamental analysis aims at studying everything which affects the value of the security, including macro-economic factors (such as the overall economy and industry conditions) and company-specific factors (including financial condition and management).

Future Value

The future value (FV) refers to the value of an asset or cash at a particular date in the future which is equivalent to the value of a specified sum at present. The future value can also be explained as the amount of money which will be reached by a present investment as a result of its growth in the future. 

Gearing Ratio

Quite closely related to solvency ratio, gearing ratio is a general term recounting a financial ratio comparing some form of owner’s capital (equity) to borrowed funds. Moreover, gearing is a quantification of financial leverage, indicative of the extent to which a firm’s activities are financed by owner’s finances vs. creditor’s finances. Putting another way, gearing ratio is used mainly for analyzing a company’s capital structure and thus assessing the company’s financial position in the long run.

Horizontal Analysis of Financial Statements

Horizontal analysis of financial statements involves comparison of a financial ratio, a benchmark, or a line item over a number of accounting periods. This method of analysis is also known as trend analysis. Horizontal analysis allows the assessment of relative changes in different items over time. 

Idiosyncratic Risk

The idiosyncratic risk can be defined as the risk which affects a very diminutive number of assets, and can be almost eradicated through diversification. It is quite similar to unsystematic risk.

Implicit Costs

Implicit cost in economics, means the opportunity cost that is equal to what that has to be given up by a firm for using factors that it neither hires nor purchases. Implicit cost is actually the cost that is the consequence of using the assets, instead of lending, selling or renting them. It also means the income that is forgone from making a choice of not to work. Implicit cost is also known as implied cost, notional cost or imputed cost.

Industry Analysis

Industry analysis can be delineated as a market assessment tool which is designed to provide a business with ideas of complexity in a specific industry. Putting it simple, the industry analysis is a report that guides companies on their business strategy. 

Industry Benchmark

benchmark, basically, refers to a standard used to measure the performance of a mutual fund, security, or investment manager. Generally speaking, broad market and market-segment stock and bond indexes are used for this objective. As explained by Investopedia, while evaluating the performance of any investment, it is essential to compare it with an apt benchmark. In the financial field, there are numerous indexes used by analysts to determine the performance of a particular investment.

Internal Rate of Return (IRR)

The internal rate of return (IRR) is defined as the return rate that makes the present value of cash flows in addition to the final market value of any investment thus bringing it to the level of current market price of the same. Used frequently in determining the worth of an investment, the internal rate of return is an important calculation. 

Investment Analysis

The study to analyze the performance of a particular investment for a given investor is known as investment analysis. It is also known as the study of the past decisions made for a particular investment made.

Investment Banking

Investment banking can be explained as a form of banking which provides funds to meet the capital requirements of companies. Moreover, investment banking supports as it carries out IPOs, bond offerings, and private placement in addition to acting as a broker and helping out in accomplishment of mergers and possessions. Putting it other way, investment banking is a field of banking that helps businesses in acquiring funds. Also, besides acquiring fresh working capital, investment banking also proffers advice for wide ranging transactions a business might engage in.

Investment Management

Investment management refers to the professional management of different securities and assets so as to meet specified investment goals for the investors’ benefits. Investors may include private investors as well as institutions. Investment management is, moreover, a huge and essential global industry in its own right accountable for caretaking of trillions of dollars, yuans, pounds, euro, and yen.

Jarrow Turnbull Model

Jarrow Turnbull Model is the first models for pricing credit risk. It was developed by two people, Robert Jarrow and Stuart Turnbull. This model makes use of multiple factor and complete analysis of interest rates to calculate the probability of default. It is one of the best reduced-forms of model that helps in ascertaining credit risk. The other type of model to ascertain credit risk is structural model.

Key Performance Indicators (KPI)

The KPI can be expressed as a set of irrefutable measures used by an industry or a company to estimate or determine performance in terms of congregating their strategic as well as operational goals. The KPIs differ between companies and industries, depending upon the performance criteria or the priorities. KPI is also, sometimes, referred as ‘Key Success Indicators (KSI).’

Labor Efficiency Variance

In order to understand the labor efficiency variance properly, you will have to understand the concept and workings of standard costing first. Variance is simply a method that is used in the bigger picture of the standard costing.

Leverage Ratios

The ratios used to determine about the companies’ financing methods, or the ability to meet the obligations. There are many ratios to calculate leverage but the important factors include debt, interest expenses, equity and assets.

Leveraged Buyout

leveraged buyout (LBO) refers to the possession of a company which is funded mostly with debt obligations. Industries and companies of all sizes have been aimed by leveraged buyout transactions. Generally, leveraged buyout involves the use of a combination of different debt instruments from banks and debt capital markets.

Liquid Asset

Liquid assets can be referred as an asset that can be converted into cash quickly and with minimal impact to the price received. Generally, liquid assets are considered similar to cash for their prices being relatively stable on being sold in the open market. As per Investopedia, to be a liquid asset, it is essential for the asset to have an established market with sufficient participants to absorb the selling without significantly i8nfluencing the price of the asset.

Marginal Analysis

Marginal analysis refers to an evaluation of the additional benefits of an activity contrasted to the additional costs of that activity. Marginal analysis is used by companies as a decision making tool to provide help in increasing the profits. Moreover, marginal analysis is used instinctively to make a host of everyday decisions. Also, marginal analysis is generally used in microeconomics while analyzing the complexity of a system being affected by marginal manipulation of its comprising variables.

Marginal Revenue

Marginal revenue refers to the increase in revenue resulting from the sale of one extra unit of output. Many of the competitive firms continue to produce output until marginal revenue equals marginal cost. However, although marginal revenue can remain constant over a particular level of output quantity, it follows the law of diminishing returns and eventually slows down, with an increase in the output level.

Market Capitalization

Market capitalization can be delineated as the total dollar market value of all the outstanding shares of a company. This figure is used by the investment community to determine the size of a company as contrasted to sales or total assets figures. Market capitalization is also generally referred as “market cap.”

Market Risk

Market risk also known by some as systematic risk is when there is potential for an investor to lose the value of its factors or experience a decline in them due to the volatility of the market that is for example by the structural changes that occur in the market or the economy as whole.

Market Risk Premium

Market risk premium is the variance between the predictable return on a market portfolio and the risk-free rate. Market Risk Premium is equivalent to the incline of the security market line (SML), a capital asset pricing model.

Microeconomic Pricing Model

The Microeconomic Pricing Model is essentially a model wherein prices for a concerned good or service are determined within a given market. As per this model, the prices are determined based on the balance of demand and supply in a market.

Mixed Expenses (Semi-variable Expenses)

Overheads that are fixed in the total volume of activity but variable when calculated as per unit are called fixed overheads.

Monte Carlo Simulation

Monte Carlo Simulation implies a problem solving technique which is used to estimate the possibility of certain outcomes by running several trial runs, known as simulations, through the use of random variables. 

Most Important Financial Ratios

The most cost commonly and top five ratios used in the financial field include...

Moving Average

Moving Average is basically an indicator that is required for the purpose of conducting a technical analysis that further displays the security’s price average value over a definite period. Moving Average is often utilized for measuring momentum and also for defining areas of resistance and support. Moving averages are utilized for emphasizing a trend’s direction and for smoothing out volume and price fluctuations, which can result in misinterpretation.

Negative Equity

Negative equity is basically the name of a phenomenon. This is found to be observed the values of an asset change during different situations. For example, at the time of securing a loan, this value is less while the outstanding balance in the amount of loan is higher than its value.

Net Debt

Net debt can be expressed as a metric that indicates the overall debt situation of a company by netting the value of the liabilities and debts of a company along with its cash and other similar liquid assets. To put it simple, net debt refers to the total debt of a company minus cash on hand. As expressed by Investopedia, one of the most important factors that require consideration while investing in a company is the amount of debt carried by the company.

Net Present Value

As explained by financial authors, the Net Present Value or Net Present Worth is defined as the present values of the individual cash flows, both incoming and outgoing, of a business entity.

Net Present Value of Growth

In order for a company to calculate what the new addition or expansion project will add to the worth of the existing firm, it needs to calculate thepresent value of growth opportunities. Furthermore, an appropriate purchase price can be calculated by utilizing the present value model. The net present value of growth opportunities can be determined by deducting purchase price from the present value of growth opportunities.

Non-diversifiable Risk

Non-diversifiable risk can be referred to a risk which is common to a whole class of assets or liabilities. The investment value might decline over a specific period of time only due to economic changes or other events which affect large sections of the market. However, diversification and asset allocation can provide protection against non-diversifiable risk as different sections of the market have a tendency to underperform at different times. Non-diversifiable risk can also be referred as market risk or systematic risk.

Non-systematic Risk

Also referred as “specific risk”, “residual risk” or “specific risk”, non-systematic risk is the industry or company specific risk which is inherent in every investment. Putting it simple, unlike systematic risk affecting the entire market, it applies only to certain investments. Moreover, it is the element of price risk which can be eliminated largely through adequate diversification within a specific asset class. It is, therefore, the individual business risk related to underlying stock, if the company goes bankrupt, it can be stated as a non-systematic risk event and usually has little to do with the general recede and flow of the entire market.

Normal Deviate (Standardized Value)

The division of distance of one data point from its mean to the standard deviation of the distribution is known as normal deviate or the standardized value. A unit deviation with zero mean is standard normal deviation and it shows the variation from the average mean or the expected value.

Opportunity Cost

Opportunity cost can be defined as the cost of an alternative which must be abstained from so as to pursue a specific action. In other words, opportunity cost refers to the benefits that could have been received through an alternative action.

Optimal Capital Structure

The optimal capital structure indicates the best debt-to-equity ratio for a firm that maximizes its value. Putting it simple, the optimal capital structure for a company is the one which proffers a balance between the idyllic debt-to-equity ranges thus minimizing the firm’s cost of capital. Theoretically, debt financing usually proffers the lowest cost of capital because of its tax deductibility. However, it is seldom the optimal structure for as debt increases, it increases the company’s risk.

Pareto Principle (80–20 Rule)

Pareto principle which is also known as the 80 to 20 rule was created by Vilfredo Pareto who was an Italian economist in the year 1906. This formula was created to explain the unequal distribution of wealth assuming that 20 percent of the people of the country hold 80 percent of the total wealth. At the end of the year 1940, DR. Joseph M. Juran attributed this rule to Pareto calling it the Pareto Principle.

Passive Management

Passive management refers to a style of management related to mutual and exchange traded funds wherein a fund’s portfolio reflects the market index. Passive management is the converse of active management which includes attempt by a fund’s manager to beat the market with different investing strategies and selling/buying decisions of securities of a portfolio. Passive management is also referred as ‘passive strategy’, ‘index investing’, and ‘passive investing.’

Payback Period

In simple terms, payback period can be defined as a tool of capital budgeting which calculates the length of time required to recover the original invested amount. This period is usually expressed in years and can be calculated using simple dividing total investment on a project and annual cash inflow.

Performance Indicator

performance indicator refers to an industry jargon term for a type of performance measure. The performance indicators are, generally, used by an organization for evaluating its achievements or the achievements of a specific activity it is engaged in. Many a times, success is defined in terms of progressing towards strategic goals, but very often, success is simply referred as the repeated achievement of some level of operational goals.

Perpetuity

Perpetuity can be well defined as an annuity without any end, or it can be said that perpetuity features a stream of cash payments continuing forever. To describe in detail, perpetuity is an annuity wherein the periodic payments commence on a specific date and continue to an indefinite time. 

Present Value

The Present Value of an entity can be defined as the present worth of a prospective amount of money or a stream of cash flows with a specified return rate. The Present Value is conversely related to the discount rate. 

Price Sensitivity

Price sensitivity is also known as price elasticity of demand and this means the extent to which sale of a particular product or service is affected. Another way of explaining price sensitivity is, “the consumer demand for a product is changed by the cost of the product. It basically helps the manufacturers study the consumer behavior and assists them in making good decisions about the products.

Production Possibility Frontier

In economics, the term production possibility frontier refers to a graph that is used for comparing the rates of production of two commodities that make use of the same fixed total of factors of production. Production possibility frontier is also known as production possibility curve, production transformation curve and production possibility boundary.

Qualitative Analysis

qualitative analysis is a technique which uses complex mathematical and statistical modeling, measurement and research to evaluate things. There could be a number of reasons behind conducting this analysis and may include: measurement of progress; performance evaluation; prediction of related global events and valuation of financial instrument. For a business individual or company it is very important to keep a check on all these factors in order to smoothen progress his business.

Quantitative Analysis

Quantitative analysis is a business or financial analysis technique that aims at understanding behavior through the use of complex mathematical and statistical modeling, measurement, and research. 

R-Squared

R-squared is a statistical measure that provides with data in percentage of a fund from the standard index or by definition the value of fraction of variance. The value of R-squared can vary from 0 to 100. If the R-squared of a security is 100, it denotes that all the movements of security are completely ascertained by the standard movement of market index.

Ratio

Ratio can be defined as one value divided by another. The resultant value is an indicator of the value of one quantity in other quantity’s terms.

Ratio Analysis

Ratio analysis is a tool brought into play by individuals to carry out an evaluative analysis of information in the financial statements of a company. These ratios are calculated from current year figures and then compared to past years, other companies, the industry, and also the company to assess the performance of the company. Besides, ratio analysis is used predominantly by proponents of financial analysis.

Regression Analysis

Regression analysis is the process of determining how the value of a dependent variable changes when any one of independent variable changes. The values of other independent variables do not change in this process.

Residual Income (RI)

Residual income is the net operating income that is earned by the investment center. This income is the earning that is above the minimum target return. This means that a residual income is the excess income earned on the return on investment.

Risk-Adjusted Discount Rate

An estimation of the present value of cash for high risk investments is known as risk-adjusted discount rate. A very common example of risky investment is the real estate. Risk adjusted discount rate is representing required periodical returns by investors for pulling funds to the specific property. It is generally calculated as a sum of risk free rate and risk premium. The variation of risk premium is depending on the risk aversion of investor and the perception of investor about the size of property’s investment risk.

Riskless Rate of Return

Risk free rate of return refers to the theoretical rate of return of an investment involving zero risk. The riskless rate represents the interest expected by an investor from a completely riskless investment over a certain time period. 

Seasonally Adjusted Annual Rate (SAAR)

SAAS is a rate adjustment used for economic or business data that attempts to remove the data’s seasonal variations. 

Sensitivity Analysis

By keeping track of the changes in the external factors, necessary actions can be taken to prevent the losses. In order to keep track of the external changes, the entity needs to implement a method that will help it determine the sensitivity of its sales, costs and changes in its income patterns. This method is known as sensitivity analysis. The sensitivity analysis determines the changes in the quantifiable variables of the project to determine it viability.

Sharpe Ratio

Nobel Laureate William F. Sharpe has derived a formula that helps to measure the risk adjusted performance. As per definition, Sharpe Ratio helps in arriving at an answer which helps us analyse the risk that can be, and allowing you to make decisions on investments and also helps analyse the performance of a group.

Solvency

In finance, solvency refers to the extent to which the current assets of a business entity exceed its current liabilities. Solvency can also be defined as the ability of a business to congregate its long term fixed expenses in addition to accomplishment of long term growth and expansion.

Solvency Ratio

Solvency ratio is one of the various ratios used to measure the ability of a company to meet its long term debts. Moreover, the solvency ratio quantifies the size of a company’s after tax income, not counting non-cash depreciation expenses, as contrasted to the total debt obligations of the firm. Also, it provides an assessment of the likelihood of a company to continue congregating its debt obligations.

Standard Deviation

The general definition of standard deviation can be given as a measure of the dispersion of a set data from its mean.

Standard Error

The deviation from the actual mean of a population is known as the standard error. In statistics the standard deviation of the sampling distribution is known as the standard error.

SWOT Analysis

SWOT analysis refers to a tool that recognizes the Strengths, Weaknesses, Opportunities, and Threats of an organization. Generally, SWOT is a basic, simple model that evaluates the capabilities of an organization as well as its potential opportunities and threats. The method of SWOT analysis is to obtain info from an environmental analysis and separate it into internal and external issues. Once this is accomplished, SWOT analysis determines what may help the firm in accomplishment of its aims and objectives, and also in overcoming or mitigating the obstacles to achieve desired results.

Systematic Risk

Systematic risk refers to the risk intrinsic to the complete market or the complete market segment. Systematic risk is also sometimes referred as “market risk” or “un-diversifiable risk”.

Terminal Value

Terminal value is the worth of your investment after a certain period of time. It is calculated by keeping factors like the current worth of asset, the rate of interests etc. In consideration yet assuming a stable rate of growth. Terminal value is sometimes also known as horizon value or continuing value. It is also used with the discounted cash flow (which calculates the firms worth for up to 3 to 5 years) to calculate the current worth of the firm or business. The terminal value of assets or of a company can be calculated beyond the time period of the discounted cash flow projection.

Time Value of Money

The time value of money refers to the value of money existing in a given amount of interest which is earned during a specific time period. The time value of money can be explained as the central concept in finance theory. Moreover, the concept of time value of money also helps in evaluating a likely stream of income in the future in a manner that the annual incomes are discounted and added thereafter, thereby providing a lump-sum present value of the complete income stream.

Trend Analysis

Trend analysis is one of the tools for the analysis of the company’s monetary statements for the investment purposes. Investors use this analysis tool a lot in order to determine the financial position of the business. In a trend analysis, the financial statements of the company are compared with each other for the several years after converting them in the percentage. In the trend analysis, the sales of each year from the 2008 to 2011 will be converted into percentage form in order to compare them with each other.

Treynor Ratio

Jack Treynor found the formula for the Treynor Ratio. It is the ratio that measures returns earned in surplus of which could have been earned on a risk free speculation per each unit of market risk. The excess return is the difference between a group’s return and the risk-free rate of return of the same period of time.

Variable Costs

Variable costs can be defined as expenses which keep changing in proportion to the activities of a business. Variable costs can be calculated as the sum of marginal costs over all units produced.

Vertical Analysis of Financial Statements

Vertical analysis of financial statements is a technique in which the relationship between items in the same financial statement is identified by expressing all amounts as a percentage a total amount. This method compares different items to a single item in the same accounting period.

Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) can be explained as the rate expected to be provided by a company on average to all the security holders for financing its assets.

Weighted-Average Cost Flow Assumption

In this method of weighted average cost flow assumptions, the periodic inventory method is used, which is employed to compute the value of the inventory in addition to the costs of the goods sold. This cost that is the average of the total cost is based on the costs of goods available for sale in the inventory for the entire year. This average cost is then applied to the units that have been sold and the units that are still in the inventory.

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