Definition

A checking account is a financial account held at a bank or credit union that is designed for everyday transactions and easy access to funds.

What is a checking account?

A checking account allows account holders to deposit money, make withdrawals, write checks, and conduct various electronic transactions. It serves as a central hub for managing day-to-day financial activities.

Deposits and withdrawals:

1. Deposits: Account holders can deposit money into their checking accounts through various methods, such as cash, checks, direct deposits, or electronic transfers.
2. Withdrawals: Funds can be withdrawn from a checking account using methods such as checks, ATM withdrawals, electronic transfers, or debit card transactions.

Checking accounts typically include a checkbook, allowing account holders to write checks as a form of payment. Checks are written to specific payees and can be used for various transactions, including bill payments and purchases. Furthermore, many checking accounts come with a debit card, which can be used to make purchases, withdraw cash from ATMs, and conduct point-of-sale transactions. Debit card transactions are directly linked to the checking account balance.

Some checking accounts offer overdraft protection, a service that helps prevent transactions from being declined if the account balance is insufficient. Overdraft protection may involve linking the checking account to a savings account or a line of credit.

While checking accounts traditionally do not offer high-interest rates compared to savings accounts or other investment options, some financial institutions provide interest-bearing checking accounts that offer modest interest on the account balance.

Checking accounts often incorporate security features to protect against unauthorised transactions. Account holders are typically protected by fraud monitoring, and many banks offer zero-liability policies for unauthorised transactions.

Example of checking account

John Doe opens a checking account at ABC Bank to manage his day-to-day financial transactions.

1. Initial deposit:
   • To activate the checking account, John makes an initial deposit of $500. This amount is the opening balance in his checking account.
2. Direct deposit:
   • John sets up direct deposit with his employer, so his monthly salary of $2,500 is directly credited to his checking account.
3. ATM withdrawals:
   • John occasionally withdraws cash from ATMs using his debit card when needed. The withdrawn amount is deducted from his checking account balance.
4. Online banking:
   • John uses online banking to check his account balance, review transactions, and transfer funds between his checking and savings accounts.
5. Overdraft protection:
   • To avoid overdrafts, John opts for overdraft protection linked to his savings account. If his checking account balance falls below a certain threshold, funds are automatically transferred from his savings account to cover the shortfall.

Definition

Capital expenses, often referred to as capital expenditures, represent significant financial investments made by a business or an organisation to buy, upgrade, or extend the life of long-term assets.

What is capital expenses?

These assets typically have a long useful life and contribute to the company’s ability to generate revenue or improve its operational efficiency. 

Capital expenses are capitalised on the balance sheet, meaning their costs are spread over the useful life of the asset rather than expensed in the period of purchase. Businesses carefully evaluate and plan capital projects as these investments have long-term implications for the company’s financial health and operational capabilities.

Businesses incorporate capital expenses into their budgeting and strategic planning processes. Accurate forecasting and financial planning are important to make sure the availability of funds for capital projects without negatively impacting day-to-day operations.

Example of capital expenses

YZ Manufacturing Inc. is a company that specialises in producing precision machinery. The existing manufacturing equipment at XYZ Manufacturing is becoming outdated, impacting efficiency and product quality. To maintain competitiveness, the company decides to invest in new, state-of-the-art machinery.

1. Purchase of new machinery:
   • XYZ Manufacturing identifies a cutting-edge CNC (Computer Numerical Control) machine that will significantly improve production processes. The cost of the CNC machine is $500,000.
2. Installation and training:
   • In addition to the cost of the machine, XYZ incurs additional expenses for the installation of the CNC machine and training for the employees who will operate it. These costs are part of the total capital expenditure.
3. Accounting treatment:
   • In XYZ Manufacturing’s financial statements, the $500,000 spent on the CNC machine and associated installation and training costs are classified as capital expenses. These expenditures are not fully expensed in the year of purchase but are capitalised on the balance sheet.
4. Depreciation:
   • Instead of deducting the entire $500,000 from the company’s income in the year of purchase, XYZ Manufacturing will depreciate the value of the CNC machine over its useful life. This spreads the expense over multiple accounting periods, reflecting the ongoing benefit derived from the asset.

Definition

A buy-to-let mortgage is a financial product designed for individuals or investors who wish to purchase residential property for the specific purpose of renting it out to tenants.

What is a buy-to-let mortgage?

Unlike a standard residential mortgage, a buy-to-let mortgage is tailored to the unique characteristics of rental property investment.

The primary purpose of a buy-to-let mortgage is to finance a property with the intention of generating rental income. Borrowers typically seek to build a property portfolio or earn a return on their investment.

Lenders evaluate buy-to-let mortgage applications based on the potential rental income of the property, the borrower’s financial situation, and their ability to manage the investment. The borrower’s personal income may be considered, but the emphasis is often on the property’s income-generating potential.

Buy-to-let mortgages often require a higher deposit or down payment compared to residential mortgages. The loan amount is typically expressed as a percentage of the property’s value.

Interest rates on buy-to-let mortgages can vary, and they may be higher than those for residential mortgages. The rates may be fixed or variable, and the choice depends on the borrower’s preference and risk tolerance.

Like any investment, buy-to-let carries risks, including varies in property values, economic conditions, and changes in rental demand. Investors should carefully consider these factors and conduct due diligence before entering the buy-to-let market.

Example of buy-to-let mortgage

Sarah, an investor interested in real estate. She identifies a residential property in a popular neighbourhood with high rental demand.

1. Property purchase:
   • Sarah decides to purchase the property as an investment to generate rental income. The property’s purchase price is $200,000.
2. Buy-to-let mortgage application:
   • Instead of a traditional residential mortgage, Sarah applies for a buy-to-let mortgage from a financial institution. The lender assesses her eligibility based on her financial situation and the potential rental income.
3. Loan Approval:
   • The lender approves Sarah’s buy-to-let mortgage. They agree on a loan amount of $150,000 at an interest rate of 5%, with a loan term of 25 years.
4. Rental income:
   • Sarah finds tenants for the property, and they agree to a monthly rent of $1,000. The rental income helps cover the mortgage repayments.
5. Mortgage repayments:
   • Sarah makes monthly mortgage repayments to the lender, including both principal and interest. The monthly repayment amount is determined by the terms of the buy-to-let mortgage.

Definition

A business cycle refers to the recurring pattern of expansion and contraction in economic activity that occurs over time.

What is a business cycle?

The business cycle is a natural feature of market economies, driven by a combination of various factors, including changes in consumer spending, investment, government policies, and external economic conditions.

Phases of the business cycle:

1. Expansion: This phase is marked by increasing economic activity, rising production, employment, and consumer spending. Businesses experience growth, and optimism prevails in the economy.
2. Peak: The peak is the highest point of economic activity during an expansion. It represents the climax of growth, and it is often characterised by high employment rates and robust economic indicators.
3. Recession: Following the peak, the economy enters a recession phase, marked by declining economic activity. This phase is characterised by falling production, rising unemployment, and a decrease in consumer spending.
4. Trough: The trough is the lowest point of economic activity during a recession. It represents the bottom of the cycle, and economic indicators are at their lowest. Unemployment is typically high during this phase.

Business cycles vary in terms of duration, intensity, and the factors influencing them. Some cycles are short-lived, while others can extend over several years. 

Businesses often experience the effects of the business cycle through changes in consumer demand, access to credit, and overall economic conditions. During expansions, businesses may thrive, while recessions can pose challenges such as reduced sales and financial pressures.

Example of business cycle

1. Expansion (Boom):
   • Imagine a scenario where the economy of the fictional country of Prospera is experiencing robust growth. GDP is increasing, businesses are expanding, and employment is rising. Consumer spending is high, and investors are optimistic about the future.
2. Peak:
   • The economy reaches a peak when it’s operating at its maximum capacity. Prospera’s economy is at its strongest, with high levels of production and low unemployment. However, signs of potential overheating may emerge, such as inflationary pressures or asset bubbles.
3. Contraction (Recession):
   • After the peak, the economy enters a contraction phase. In Prospera, demand starts to slow, businesses may cut back on production, and unemployment may rise. Consumer and business confidence may decline, leading to reduced spending and investment.
4. Trough:
   • The trough represents the lowest point of the business cycle. In Prospera, economic activity has bottomed out. Businesses may be operating below capacity, unemployment is high, and consumer confidence is at its lowest. However, this phase also sets the stage for recovery.
5. Recovery:
   • The economy begins to recover as conditions improve. In Prospera, policymakers may implement measures to stimulate economic activity, such as lowering interest rates or implementing fiscal stimulus. Businesses regain confidence, production increases, and unemployment starts to decline.

Definition

A benchmark is a reference point or standard used for comparison and evaluation, serving as a measure against which the performance, quality, or characteristics of something else can be assessed. Benchmarks are widely employed across various fields, including finance, business, technology, and performance measurement, to assess the relative success or effectiveness of a company or process.

What is a benchmark?

In finance, a benchmark is often used to assess the performance of investment portfolios, funds, or financial instruments. Benchmarks are frequently established based on industry norms or recognised best practices. This allows organisations to align their performance with industry standards and identify areas for improvement.

Types of benchmarks:

1. Market benchmarks: Reflect overall market performance.
2. Competitive benchmarks: Involve comparing performance against direct competitors in a specific industry.
3. Operational benchmarks: Focus on processes and efficiency within an organisation.
4. Financial benchmarks: Include metrics like interest rates or inflation rates that influence financial decisions.

Benchmarks play a key role in continuous improvement efforts. Organisations use benchmarking results to set performance goals, track progress, and make informed decisions to improve efficiency and effectiveness.

While benchmarks are valuable for comparison, it’s essential to recognise their limitations. Differences in context, goals, and methodologies can impact the validity of comparisons. Additionally, benchmarks may not capture all relevant factors influencing performance.

Example of benchmark

Imagine XYZ Retail, a company operating in the clothing retail industry.

1. Benchmark selection:
   • XYZ Retail wants to assess its profitability compared to industry standards. They choose the industry average profit margin as their benchmark.
   • Let’s say the average profit margin for the clothing retail industry is 10%.
2. XYZ Retail’s profit margin:
   • XYZ Retail reviews its financial statements and calculates its own profit margin, which is the ratio of net profit to total revenue.
   • If XYZ Retail’s profit margin is 12%, it indicates that the company is performing better than the industry average in terms of converting sales into profits.
3. Interpretation:
   • Outperforming the benchmark suggests that XYZ Retail is more efficient in managing costs and generating profits compared to the industry norm.

Definition

A base rate, in the context of finance and banking, refers to a benchmark interest rate that serves as a reference point for determining the interest rates on various financial products.

What is a base rate?

Central banks or monetary authorities typically set the base rate as a tool to influence economic conditions, particularly to control inflation.

The base rate is often set by a country’s central bank. Central banks use the base rate as a monetary policy tool to regulate borrowing costs and money supply in the economy. The interest rates on loans and other financial products are commonly linked to the base rate. When the base rate changes, financial institutions adjust their interest rates accordingly. For example, a rise in the base rate may lead to higher borrowing costs for consumers and businesses.

The base rate also affects interest rates on savings accounts and other interest-bearing deposits. When the base rate increases, savers may see higher returns on their deposits, while a decrease in the base rate could result in lower interest earnings.

Changes in the base rate are often seen as indicators of the central bank’s stance on monetary policy. A higher base rate may indicate a desire to lower inflationary pressures, while a lower base rate is typically employed to stimulate economic activity and lending. Central banks periodically review and adjust the base rate based on economic conditions, inflation targets, and other relevant factors. These adjustments are communicated to the public and financial institutions.

Example of base rate

A commercial bank, XYZ Bank, decides to offer a loan to a customer. It may determine the interest rate for the loan by adding a margin to the central bank’s base rate. Suppose XYZ Bank adds a margin of 2% to the base rate.

• XYZ Bank’s lending rate = Central bank base rate + margin
• XYZ Bank’s lending rate = 3% = 2% = 5%

Therefore, XYZ Bank offers the loan to the customer with an interest rate of 5%, where 3% represents the central bank’s base rate, and 2% is the bank’s margin.

Definition

Accounts receivable refers to the outstanding amounts that a business is yet to collect from its customers or clients for goods sold or services provided on credit. It represents the short-term financial obligations owed to the company.

What is accounts receivable

When a business extends credit to customers, it essentially allows them to defer payment for a later date, creating an accounts receivable.

Some key points about accounts receivable include:

1. Credit transactions: Accounts receivable arise from credit transactions where a company provides goods or services to customers with an agreement for deferred payment. 
2. Recorded as asset: In financial statements, accounts receivable are recorded as assets on the balance sheet. They represent a claim that the company has on the payment from its customers. 
3. Terms and conditions: The terms and conditions for payment, including the credit period and any interest or discounts, are usually specified in the sales agreement or invoice. 
4. Working capital impact: Accounts receivable impact a company’s working capital. While they are assets, a high level of receivables may indicate potential liquidity issues.
5. Monitoring and collections: Businesses closely monitor their accounts receivable to ensure timely collection. This involves tracking overdue payments, sending reminders or statements to customers, and implementing collection strategies if necessary.
6. Bad debt provision: Recognising that not all accounts receivable may be collected, companies often establish a provision for bad debts. This is an estimate of the portion of receivables that may not be collected due to customer defaults.
7. Financial analysis: Analysts and investors may assess a company’s accounts receivable revenue ratio to evaluate how quickly it is collecting outstanding payments. A high revenue ratio is generally favourable, indicating effective credit management.

Example of accounts receivable

1. Service Provided on Credit:
   • On March 1st, ABC Services provides consulting services to a client, XYZ Corporation, and invoices them for $8,000. The payment terms are net 30 days, meaning XYZ Corporation has 30 days to pay the invoice.

   The accounting entry for this transaction is:

   $\text{Accounts receivable}(Asset)=\; \$8,000$

   $\text{Service revenue}(Revenue)=\; \$8,000$

   This entry reflects an increase in the accounts receivable asset, representing the amount owed by the client, and an increase in service revenue.

2. Payment within Credit Terms:
   • On March 25th, within the credit period, XYZ Corporation makes a payment of $8,000 to ABC Services.

   The accounting entry for the payment is:

   $\text{Cash}(Asset)=\; \$8,000$

   $\text{Accounts receivable}(Asset)=\; \$0$

   This entry reduces the accounts receivable and increases the cash asset to reflect the payment received.

In this example, accounts receivable initially represents the amount owed to ABC Services by its client for services rendered. The asset is later reduced when the payment is received within the specified credit period.

Definition

An accounting period, also referred to as a fiscal period or financial period, is a defined span of time during which a business records its financial transactions and prepares financial statements.

What is an accounting period?

This period serves as the basis for reporting the organisation’s financial performance and position. The duration of an accounting period can vary and is typically chosen based on the specific needs and practices of the business. Common periods include a month, a quarter, or a year.

The primary reason for establishing an accounting period is to systematically organise financial data, enabling accurate and meaningful presentation of a business’s economic activities. Financial statements, such as the income statement, balance sheet, and cash flow statement, are generated at the conclusion of each accounting period. These statements offer a consolidated view of revenue, expenses, assets, liabilities, and cash flows during the specified timeframe.

Beyond financial reporting, accounting periods play an important role in budgeting and planning. Businesses align their budgets with specific periods to monitor and evaluate performance against predetermined expectations. For tax reporting, it’s usually necessary to follow a specific accounting period that lines up with the fiscal year.

Example of accounting period

Let’s consider a short example of a monthly accounting period for a small business, XYZ Services:

• During January, XYZ Services provides consulting services and invoices clients for $10,000.
• Incurs monthly operating expenses, including rent and utilities, totaling $5,000.

At the end of January, the financial summary for reporting purposes is:

Revenue = $10,000

Expenses = $5,000

This represents a snapshot of XYZ Services’ financial position for the specific month of January. The company will repeat this process each month.

Definition

A discount rate in business and finance refers to the interest rate used to determine the present value of future cash flows or financial instruments.

What is a discount rate?

A discount rate plays a crucial role in various financial calculations, including the valuation of investments, assessing the worth of a business, and making decisions about capital budgeting and project feasibility.

The concept of a discount rate is rooted in the principle of the time value of money. It recognises that a pound received in the future is worth less than a pound received today due to the opportunity to invest and earn a return.

The discount rate also reflects the opportunity cost of capital. It represents the return that could be earned by investing the same amount of money in an alternative opportunity with similar risk.

Example of discount rate

Let’s say you are considering an investment that is expected to generate $1,000 one year from now. If the discount rate is 5%, the present value of that future cash flow would be calculated as follows:

Present value = Future cash flow / (1 + Discount rate) = $1,000 / (1 + 0.05) = $952.38

So, the present value of receiving $1,000 one year from now, with a discount rate of 5%, is $952.38.

Definition

Export refers to the process of selling goods or services produced in one country to customers or businesses located in another country. This activity plays a crucial role in the global economy, allowing businesses to expand their markets beyond their domestic borders and tap into international opportunities.

What is export?

By exporting, businesses can reach a diverse range of customers with varying preferences, needs, and purchasing power. This diversification can help mitigate risks associated with economic fluctuations in a single market.

Engaging in international trade can provide a competitive advantage by allowing businesses to leverage their unique products, technologies, or services in markets where they may have a comparative advantage.

Before entering a new market, businesses need to conduct thorough market research to understand the local demand, competition, and cultural nuances. They also need to develop effective entry strategies.

International trade involves various risks, including political instability, economic fluctuations, and changes in trade regulations. Businesses engaging in exporting need to develop strategies to mitigate these risks.

Exporting often involves dealing with customers from different cultural backgrounds and languages. Effective communication and providing excellent customer support are critical for building trust and long-term relationships.

Example of export

Imagine a clothing manufacturer, “Fashion Trends Inc.,” based in the US. The company produces high-quality denim jeans and decides to sell its products internationally. Fashion Trends Inc. enters into agreements with retailers in Europe and Asia to distribute and sell its jeans in those markets.

In this scenario:

• Fashion Trends Inc. is the exporter.
• The denim jeans are the exported goods.
• The international retailers are the importers or buyers.

Fashion Trends Inc. ships a container of denim jeans to the foreign retailers, who will then sell the jeans in their respective markets. The revenue generated from these international sales contributes to Fashion Trends Inc.’s overall business and potentially expands its customer base beyond the United States.

Definition

A competitive advantage refers to a specific attribute or set of attributes that allows a business or organisation to outperform its rivals in a market or industry. It gives the entity an edge over competitors, enabling it to generate higher revenues, capture market share, or achieve superior profitability.

What is a competitive advantage?

Competitive advantages can be derived from various factors and strategies, and they play a pivotal role in a company’s success and sustainability.

Key types of competitive advantages:

1. Cost advantage: Achieving lower production costs or operational expenses than competitors, allowing the company to offer products or services at a lower price while maintaining profitability.
2. Differentiation advantage: Providing unique or distinctive products, services, or features that are valued by customers and are not easily replicated by competitors.
3. Focus strategy: Concentrating on a specific market segment, niche, or geographic area, and tailoring products or services to meet the specific needs and preferences of that target market.
4. Technological edge: Being a leader in technology, innovation, or proprietary knowledge that provides a distinct advantage in product development, production processes, or service delivery.
5. Brand and reputation: Having a strong brand image and reputation in the market, which can lead to customer loyalty, trust, and preference over competitors.

Companies can achieve competitive advantage not only domestically but also in the global market by leveraging factors like economies of scale, international brand recognition, and access to diverse markets.

Example of competitive advantage

XYZ Electronics invests heavily in research and development, leading to the creation of cutting-edge products with advanced features and functionalities.

1. Cost leadership:
   • Through efficient manufacturing processes and strategic sourcing, XYZ Electronics manages to produce its electronic devices at a lower cost compared to competitors.
2. Brand recognition:
   • XYZ Electronics has built a strong and recognisable brand through effective marketing and a reputation for quality products. Consumers trust the brand, which often results in higher sales.
3. Customer service excellence:
   • The company prioritises exceptional customer service, providing timely support, easy returns, and warranty services. This enhances customer satisfaction and loyalty.
4. Strategic partnerships:
   • XYZ Electronics has formed strategic partnerships with key suppliers and distributors, securing preferential terms and ensuring a reliable supply chain.
5. Talent and expertise:
   • The company attracts top talent in engineering and design, giving it a competitive edge in creating innovative products that meet and exceed customer expectations.

Definition 

A cash flow statement is a financial statement that provides a summary of how a company manages its cash position over a specific period of time. It shows the inflows and outflows of cash and cash equivalents, categorising them into operating, investing, and financing activities. 

What is a cash flow statement?

The primary purpose of a cash flow statement is to provide a detailed account of how changes in a company’s balance sheet and income statement affect its cash and cash equivalents. It helps stakeholders, including investors, creditors, and management, understand how the company generates and uses cash.

There are three main categories:

1. Operating activities: This section includes cash flows from the core business operations of the company.
2. Investing activities: This section covers cash flows from activities that involve long-term assets. 
3. Financing activities: This section focuses on cash flows from transactions with the company’s owners and creditors.

The cash flow statement is a vital analytical tool for financial analysts, as it helps in evaluating the quality of a company’s earnings and its capacity to generate sustainable cash flows, and it provides insights into a company’s ability to withstand economic downturns or unforeseen financial challenges by showing its liquidity and cash flow management.

Example of cash flow statement

This simplified cash flow statement demonstrates how cash is generated and used by a company in its activities during a specific period.