From insolvency to administration, many finance and business terms can be quite confusing and difficult to understand, particularly to people without a background in the industry.
Whether you’re a company director aiming to sharpen your knowledge of business terms or a future entrepreneur hoping to learn the basic language of business, read on to learn 20 common words and phrases used in business and finance.
A business is insolvent when it can’t pay its debts, or when its liabilities are greater than its assets. These two types of insolvency are referred to as cash flow insolvency and balance sheet insolvency, respectively.
When a business becomes insolvent, it can be wound up by its creditors or can use procedures such as a CVA or administration to restructure and continue trading.
Cash flow is the flow of cash into and out of a business. Cash flow can be positive or negative. Positive cash flow is when more cash comes into a business than exits, and negative cash flow is when more cash flows out of a business than enters it.
Businesses with consistently negative cash flow could run out of cash and become insolvent over time.
Net income is a business’s total profit. Businesses calculate net income by taking the amount of revenues generated over a specific period and subtracting costs including expenses, depreciation, taxes and other costs.
Although net income may sound similar to cash flow, it’s very different. While cash flow measures only the flow of cash into a business, net income includes a business’s accounts receivable.
Revenue is the total amount of money that a business generates. Revenue is often referred to as “sales” or “gross income”, as it’s the total amount of money that any business generates during a specific period before costs are subtracted.
Earnings are the total amount of money a business generates after taxes have been deducted from its profits. Most companies measure their earnings on a quarterly or annual basis, with public companies publishing this information for shareholders.
Debt service is the amount of cash that a business needs to pay over the period of its loan to repay the loan and interest. For a small business, debt service could include a mortgage and small business loan.
Principal refers to the amount of money borrowed as part of a loan, or the amount of money still owed to the lender, excluding interest. Once a business pays back the principal, it’s no longer in debt to the lender.
Secondary refers to the amount of interest owed on a loan. The principal of a loan is the total amount of money borrowed, whereas the secondary is the interest that the borrower repays over the course of the loan period.
An interest rate is the cost of borrowing money. Interest rates are a percentage of the principal, usually calculated on an annual basis. Interest rates vary based on a range of factors, including the risk involved with lending money to the borrower.
Equity is the value of an asset – typically property such as real estate or shares in a company – minus its debts. The term “equity” is most commonly used to refer to an ownership stake in a private or public company, or in property such as real estate.
Debentures are unsecured debt instruments. Unlike certain loans, which are secured by a personal guarantee or collateral, debentures are unsecured bonds that are used by companies in order to raise capital.
Liquidation is the process of selling a company’s assets after the company has failed to service its debts. The cash generated by a liquidation sale is used to compensate a company’s creditors.
Administration is a procedure for insolvent companies. When a company enters into administration, an insolvency practitioner takes over direction of the company in an attempt to improve its finances and facilitate a recovery.
Creditors are parties that provide credit to a business or individual. There are many types of creditors, ranging from banks and finance companies to suppliers paid on a trade credit basis.
In exchange for providing cash, goods or services to a business, creditors are paid at a specified date by the borrower.
Shareholders are owners of a company’s stock. Shareholders can be individuals or institutions, such as another company. Shareholders own equity in a company and benefit from its financial success through stock value and dividends.
A winding up petition is an application to liquidate your company presented to the court by one of its creditors. A creditor can petition to wind up your company if it’s owed more than £750 and hasn’t received payment following a statutory demand.
A directors loan account is an account between yourself (as company director) and your company that allows you to fund or borrow from your business. Unlike a bank account, a directors loan account is not a real account – it is recorded and managed via your company’s accounting records.
Pre-pack administration is a process that allows your company to sell certain assets in a pre-packaged sale to another company. Using pre-pack administration, you can preserve contracts, the business itself and many jobs.
A company voluntary arrangement is a procedure that allows your company to pay some or all of its debts to creditors over a specified time period. Using a CVA might allow your company to continue trading after it becomes insolvent.
In order to enter into a CVA, your company’s creditors will need to accept the terms of the arrangement. CVAs typically last between two and five years, and may allow a percentage of the creditor’s debt to be written off to simplify repayment.