Five top financial terms that cause confusion
The AAT recently carried out research and found that two out of five (42%) of the UK’s finance workers admitted that they found terminology at work confusing, or didn’t understand what it meant. So we’ve made a simple guide to the terms that are the most befuddling.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)
EBITDA is a financial metric used to evaluate a company’s operational performance and profitability. It provides a clear picture of the company’s earnings potential by excluding non-operating expenses like interest, taxes, depreciation, and amortisation. EBITDA is commonly used by investors, analysts, and creditors to compare the profitability of different companies within the same industry or to assess a company’s ability to generate cash flow from its core operations.
Liquidity ratio
The Liquidity Ratio is a financial metric used to assess a company’s ability to meet its short-term obligations with its liquid assets. It measures the proportion of liquid assets, such as cash and equivalents, to short-term liabilities. A higher liquidity ratio indicates a stronger ability to cover short-term debts and expenses, while a lower ratio may suggest potential liquidity challenges. This ratio is important for investors, creditors, and analysts to evaluate a company’s financial health and its ability to weather short-term financial strains.
Leverage ratio
The Leverage Ratio is a financial metric used to assess the level of debt a company has relative to its equity and other financial assets. It measures the proportion of a company’s debt to its equity, providing insight into its financial risk and stability. A higher leverage ratio indicates higher financial risk, as the company relies more on debt financing, while a lower ratio suggests a healthier balance between debt and equity. This ratio is crucial for investors, creditors, and analysts to evaluate a company’s financial structure and its ability to manage debt obligations.
Accrual accounting
Accrual accounting is a method of accounting that records revenues and expenses when they are earned or incurred, regardless of when cash is exchanged. This approach contrasts with cash accounting, where transactions are recorded only when cash is received or paid. Accrual accounting provides a more accurate picture of a company’s financial performance by matching revenues with the expenses incurred to generate them, offering a clearer view of profitability over a specific period. This method is commonly used by businesses to comply with accounting standards and to provide more informative financial statements for investors, creditors, and stakeholders.
Treasury management
Treasury management refers to the strategic management of a company’s financial assets, liabilities, and cash flows to optimise liquidity, minimise financial risk, and maximise returns. It involves overseeing various aspects such as cash management, liquidity management, risk management, investment management, and capital structure management. Effective treasury management ensures that a company has the necessary funds to meet its financial obligations while also making prudent decisions to enhance profitability and shareholder value. This function is crucial for businesses of all sizes to maintain financial stability and support long-term growth objectives.
Still need help with confuzzling terms?
Get in touch with your tutor or our team to help explain the trickier topics. And if you’re intrigued about accounting, read our accountancy guide and see which course would suit you best.