Glossary - Investment
Acid Test Ratio - The acid test ratio is a method of determining whether a business has sufficient short-term assets to cover its immediate liabilities. It is regarded as a far more stringent indicator than ‘working capital ratio’ because it does not allow for the inclusion of ‘inventory assets’ such as stock on hand. It can be calculated by the following: Cash + Accounts Receivable + Short-Term Investments less Current Liabilities. The term comes from the ‘acid test’ gold miners would use to check if they had discovered real gold nuggets.
Business Valuation - The process by which the economic value of a business, or the value of a specific owner/partner’s interest, is determined. A business valuation may be required by a potential purchaser or shareholder, by an owner/partner who is intending to sell, in situations where the company intends to raise capital, or in the case of divorce proceedings, etc. There is no standard method of valuation, and approaches can include a review of cash flow statements, discounting cash flow models, or comparison with a reasonably similar business whose value is already known.
Compound Growth - A measure of how much something (typically an investment) grew on average, per year, over a multi-year period, as a result of the effects of compounding. As an example, a 7% compound growth rate over 10 years would result in R100 becoming almost R200. But without compounding that same R100 would only earn R7 each year and reach just R170 over 10 years.
Dividend - A sum of money paid by a company to its shareholders out of the profits it has made or the reserves it holds. Payments are typically made quarterly or annually and will usually take the form of cash, although they may also be made in stock. Businesses are not compelled to declare a dividend, although this is good practice if it wants to attract ongoing interest from the stock market and boost its share price.
Equity - That portion of an organisation’s assets owned by shareholders (including a sole proprietor or partners), as opposed to what they have borrowed. Also known as ‘owner’s equity’ or ‘shareholder’s equity’, it is equal to total assets minus liabilities and appears on the balance sheet. In investment terms, Equity refers to ‘stocks’ and is one of the principal asset classes
Equity Financing - A method by which a company raises finance, usually by issuing shares in its stock. In smaller businesses, Equity Financing may also come from the owner, via investments from family and friends, or from an Angel
Investor (see listing under ‘A’) - As a rule, potential investors look positively on an owner’s Equity Financing contribution, as it indicates that he or she is willing to share the business risk.
Leverage - A measurement of the amount of debt a business is using to finance its operations and to create assets. A company with notably more debt than equity is said to be ‘highly leveraged’ and may be at risk of bankruptcy if it becomes unable to meet its debt repayments. Being too highly leveraged also makes it difficult to secure other loans in the future. However, if properly managed, being highly leveraged can also increase return on investment.
Long-term Interest Rate - Is usually associated with investments or other financing options which have a lifespan of 10 years or more (for example, government-issued bonds). A benefit of Long-Term Interest Rates is that they tend to be more stable and predictable than short-term ones. However, the rate of interest is usually lower.
Market Share - The share of business (usually expressed as a percentage) that a company, brand or product has in its industry or market segment. It is used to measure its relative success versus competitors, as well as to gauge potential for expansion. Investors will also use market share figures to decide whether a business is likely to be a profitable investment. Market share is calculated by taking total sales over a specified period and dividing it by the total sales in that industry/sector over the same timeframe.
Premium - The amount at which a product or service is valued, over-and-above its intrinsic value. This will frequently be as a result of a premium brand image generated by marketing and pricing strategies. For example, a Gucci-branded handbag will sell at a premium price versus an identical handbag without the Gucci label. In investment terms, Premium refers to the amount at which a securities option is traded. In Insurance terms, a Premium is the amount paid monthly (or at another agreed interval) to ensure a policy remains active.
Private Company - The opposite of a Public Company, in which stocks and shares are traded on the open market, usually via a stock exchange. A Private Company will typically be owned by an individual or partners, and is not required by law to publish annual results or to open its accounts or activities to public scrutiny. South African tax law recognises Private Companies, Public Companies and Close Corporations.
Publicly Traded - The opposite of a Private Company. It trades stocks and shares on the open market, typically via a stock exchange or stock brokers. Owned by shareholders and governed by a board of directors, it is required by law to publish annual results and to open its accounts and activities to public scrutiny and to abide by codes of good governance. South African tax law recognises Private Companies, Public Companies and Close Corporations.
Retained Earnings (Retained Surplus or Retention Ratio) - This is the percentage of net earnings which is not paid out to shareholders as a dividend, but is instead retained by the business to re-invest in its operations or to pay off core debt. In accounting terms, Retained Earnings is a general ledger account and is adjusted each time an entry is recorded in an income or expense account.
Return on Assets (ROA) - It is a measurement of the earnings which have been generated by the invested capital in a business. The figure tells investors, the board of directors, and senior management how effective the company was in converting that capital into assets of value. The ideal is to make large profits from little investment. ROA is measured as a percentage and the formula is calculated as follows:
Net income ÷ Total assets
Return on Investment (ROI) - It is a measurement of the earnings which have been generated by the invested capital in a business. The figure tells investors, the board of directors, and senior management how effective the company was in converting that capital into investments of value. The ideal is to make large profits from little investment. ROI is measured as a percentage and the formula is calculated as follows:
Net income ÷ Total Investments
Seed Capital (Starting Capital) - It is the capital needed by a business to get started. This may come from the personal assets of the founder or from family and friends. It may also be supplied by an Angel Investor, an affluent individual who invests in an entrepreneurial start-up or expansion, in the hope of receiving a very high Return on Investment in a relatively short timeframe. Venture Capitalists and traditional banks usually view businesses in the start-up phase as high risk and are reluctant to provide Seed Capital.
Shareholder (Stockholder) - It is an individual, institution or business which owns at least one share (although usually many) in a public company. Shareholders are regarded as the ultimate ‘owners’ of a public company and the board and management is answerable to the Shareholders. Although Shareholders will profit when the business does well, they also share in the risk of a loss when the business performs poorly.
Short-Term Assets (Current Assets) - These are assets of a business which are likely to be converted into cash, sold or consumed within a single operating cycle of the business, typically a calendar year or financial year. Short-Term Assets are likely to include cash in hand, accounts receivable, or any other monies due in that timeframe, as well as stock held by the business. In investment terms, it is a security which matures in one year or less.
Starting Capital (Seed Capital) - It is the capital needed by a business to get started. This may come from the personal assets of the founder or from family and friends. It may also be supplied by an Angel Investor, an affluent individual who invests in an entrepreneurial start-up or expansion, in the hope of receiving a very high Return on Investment in a relatively short timeframe. Venture Capitalists and traditional banks usually view businesses in the start-up phase as high risk and are reluctant to provide Starting Capital.
Stock (Shares) - It is a security which signifies ownership or part-ownership of a business and entitles the holder to share in the assets and earnings (as well as the losses). A holder of Stock is a Shareholder in the business. Stock may also refer to the goods or merchandise held by a manufacturer, wholesaler or retailer – and which is available for sale or onward distribution.
Stock market - A loose network of economic transactions in which stocks and shares in public companies are traded, either within specified geographical boundaries or globally. The physical manifestation of the Stock Market is the Stock Exchange (such as the Johannesburg Stock Exchange, New York Stock Exchange, etc) which houses brokers and regulates the trading activities in accordance with applicable laws and financial rules.