Definition

Current liabilities are financial obligations and debts that a company is expected to settle within one year or within the normal operating cycle of the business.

What are current liabilities?

This type of liabilities represent the portion of a company’s liabilities that are due in the short term.

Common examples of current liabilities include:

1. Accounts payable: These are amounts owed by a company to its suppliers or vendors for goods or services received on credit. 
2. Short-term debt: This includes any loans, notes, or credit facilities that are due for repayment within one year.
3. Accrued liabilities: These are expenses that have been incurred but have not yet been paid.
4. Deferred revenue: This represents payments received from customers in advance of goods or services being delivered. It is a liability until the product or service is provided.

Current liabilities, along with current assets, form a critical component of a company’s working capital. Maintaining an appropriate balance between current assets and current liabilities is essential for managing cash flow and short-term financial obligations.

Current liabilities are prominently featured in a company’s balance sheet, providing a snapshot of its financial position at a specific point.

Distinguishing between current and long-term liabilities is essential for understanding a company’s financial health. Creditors and investors closely monitor a company’s current liabilities as part of their assessment of its financial stability and ability to meet short-term obligations.

Example of current liabilities

Here’s an example of current liabilities for a fictional company, ABC Corporation:

• Accounts Payable: ABC Corporation owes $50,000 to suppliers for raw materials and services that have been received but not yet paid.
• Short-Term Loans: The company has a short-term loan with a bank, and the outstanding amount due within the next year is $30,000.
• Accrued liabilities: ABC Corporation has accrued $20,000 for wages and other expenses that have been incurred but not yet paid.
• Income taxes payable: The company owes $15,000 in income taxes for the current fiscal year.
• Short-term portion of long-term debt: ABC Corporation has a long-term loan, and $40,000 of it is due for payment within the next year.

Now, if you sum up these current liabilities:

Current liabilities = $50,000 + $30,000 + $20,000 + $15,000 + $40,000 = $155,000

In this example, ABC Corporation has $155,000 in current liabilities, representing obligations that are expected to be settled within the next year.

Definition

Current assets refer to a category of assets on a company’s balance sheet that are expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of the business.

What are current assets?

Currents assets represent resources that are relatively liquid and can be used to meet short-term obligations and operational expenses. Furthermore, they are often used as collateral for short-term borrowing.

Common examples of current assets include:

1. Cash and cash equivalents: Physical cash, bank account balances, and highly liquid investments that can be converted to cash quickly.
2. Accounts receivable: This represents amounts owed to the company by customers or clients for goods or services provided on credit.
3. Inventory: This comprises goods held by the company for sale or production.
4. Prepaid expenses: These are payments made in advance for goods or services that will be used or consumed in the future.

Current assets are integral to a company’s working capital. Effective management of working capital ensures that a company can cover its short-term financial obligations and operational expenses. A healthy proportion of current assets relative to current liabilities suggests a company’s ability to meet its short-term obligations.

Current assets are prominently featured in a company’s balance sheet, which provides a snapshot of its financial position at a specific point.

Example of currents assets

Definition

Crowdfunding is a method of raising capital where a large number of individuals each contribute a relatively small amount of money to support a specific project or idea and is an alternative to traditional methods of financing.

What is crowdfunding?

Crowdfunding can be used to fund a wide array of projects and operates through specialised online platforms that connect project creators with potential backers.

There are several crowdfunding models, including:

1. Reward-based: Individuals receive non-equity rewards.
2. Equity-based: Individuals receive a share of ownership or equity in the project or business.
3. Donation-based: Individuals contribute without expecting any financial return.
4. Debt-based (peer-to-peer lending): Individuals provide loans to the project creator, expecting to be repaid with interest.

Project creators set a specific funding goal and determine a campaign duration. If the funding goal is not met within the set duration, the project may not receive any funds. Crowdfunding campaigns can operate on an “all-or-nothing” or “keep-what-you-raise” basis. In an all-or-nothing model, the project must meet or exceed its funding goal to receive any funds. In a keep-what-you-raise model, the project creator retains all funds raised, regardless of whether the goal is met.

While crowdfunding offers opportunities for individuals to support innovative projects, there are risks involved. Projects may face delays, encounter unexpected challenges, or even fail to deliver on promised rewards.

Example of crowdfunding

Jane has a brilliant idea for a new eco-friendly product, but she lacks the funds to bring it to market. She decides to explore crowdfunding and creates a campaign on a popular crowdfunding platform.

She sets a crowdfunding target of $20,000 and offers backers different reward tiers based on their contribution levels. For instance:

• A $10 contribution might get a thank-you note.
• A $50 contribution could earn a pre-order of the eco-friendly product.
• A $100 contribution might include a personalised thank-you video and two pre-orders.

Over the course of the campaign, she successfully raises $25,000 from a combination of small contributions from numerous backers. With the funds, Jane is able to manufacture and launch her eco-friendly product, fulfilling the promises made to her backers.

Definition

A credit score is a numerical representation of your creditworthiness, which is used by lenders to assess the likelihood of a borrower repaying their debts.

What is a credit score?

A credit score is based on an analysis of your credit history, including your borrowing and repayment behaviour, and is a crucial factor in determining your eligibility for loans, credit cards, mortgages, and other forms of credit.

Here’s a list of key points related to credit score:

1. Numerical representation: A credit score is typically expressed as a three-digit number, usually ranging from 300 to 850, with higher scores indicating better creditworthiness.
2. Calculation factors: Several factors are taken into consideration when calculating a credit score. These commonly include payment history, credit utilisation, length of credit history, etc..
3. Payment history (35% of score): This assesses whether a borrower has a history of making payments on time. Late payments negatively impact this aspect.
4. Credit utilisation (30% of score): This reflects the ratio of a person’s current credit balances to their total available credit. A lower utilisation rate indicates better credit management.
5. Length of credit history (15% of score): This considers how long a person has had credit accounts open. Longer credit histories tend to be viewed more favourably.
6. Types of credit used (10% of score): Lenders prefer to see a mix of different types of credit, which demonstrates responsible credit management.
7. New credit inquiries (10% of score): Opening several new credit accounts in a short period can be an indicator of financial stress.

A high credit score is essential for obtaining favourable terms on loans and credit products. It can lead to lower interest rates, higher credit limits, and more favourable repayment terms. 

While credit scores are crucial for borrowing, they can also affect other aspects of your financial life. Landlords, insurance companies, and potential employers may also consider an applicant’s credit score as part of their evaluation process.

A common breakdown of credit score ranges is:

• 300 – 579: Poor
• 580 – 669: Fair
• 670 – 739: Good
• 740 – 799: Very Good
• 800 – 850: Excellent

Example of credit score

John recently applied for a credit card, and the credit card issuer assessed his creditworthiness based on various factors. After the evaluation, John’s credit score was determined to be 750.

Factors contributing to John’s good credit score might include:

• Payment history: John consistently pays his bills on time, with no history of late payments or defaults.
• Credit utilisation: John manages his credit responsibly, keeping his credit card balances low relative to his credit limits.
• Length of credit history: John has a solid credit history, demonstrating responsible credit management over an extended period.
• Types of credit: John has a mix of credit types, such as credit cards and instalment loans, showcasing his ability to manage different forms of credit.
• New credit: John has not opened multiple new credit accounts in a short period, avoiding actions that might suggest financial distress.

Definition

A credit facility is a financial arrangement between a lender and a borrower that provides the borrower with access to a predetermined amount of money or credit for a specified period.

What is a credit facility?

A credit facility serves as a flexible source of funding that a borrower can draw upon as needed, up to a certain limit.

Types of credit facilities:

1. Revolving credit facility: This type allows borrowers to repeatedly draw and repay funds up to a specified limit. Interest is typically charged on the outstanding balance.
2. Term loan facility: This provides a specific amount of funds for a predetermined period. Repayments are made over the term, often in instalments, until the loan is fully paid off.

Credit facilities are versatile and can be used for various purposes. They may be utilised for working capital needs, financing projects, expanding operations, or even for emergency cash flow requirements. Borrowers may be asked to provide collateral as security. This ensures that the lender has a means of recovering the funds in case of default.

Interest rates on credit facilities can be fixed or variable, depending on the terms of the agreement. The borrower is usually charged interest only on the outstanding balance.

Lenders evaluate the creditworthiness of the borrower before extending a credit facility and for revolving credit facilities, borrowers are typically required to make minimum monthly payments, which cover interest. 

Credit facilities may come with associated fees, such as annual fees, arrangement fees, or penalty charges for late payments. These terms are outlined in the credit agreement.

Credit facilities offer flexibility in terms of when and how funds are used. Borrowers have the discretion to draw on the credit line as needed, making it a convenient source of financing for ongoing or unpredictable expenses.

While a credit facility can be a valuable financial tool, it also comes with responsibilities. Borrowers are obligated to manage their credit responsibly, making timely payments and adhering to the terms and conditions outlined in the credit agreement.

Example of a credit facility

ABC Corporation, a manufacturing company, secures a credit facility from a bank to support its working capital needs. The credit facility provides ABC Corporation with access to a line of credit of up to $1 million.

As part of the credit facility agreement, ABC Corporation can borrow funds from the line of credit as needed to finance its day-to-day operations.

For instance, if ABC Corporation experiences a temporary cash flow shortage due to delays in receiving payments from customers, it can draw $200,000 from the credit facility to bridge the gap and maintain its operations.

ABC Corporation repays the borrowed funds, along with interest, according to the terms of the credit facility agreement. The company can borrow and repay funds from the credit facility multiple times within the agreed-upon period.

Definition

Corporate tax refers to a tax charged by governments on the profits earned by businesses, corporations, and other legal entities. It is a significant source of revenue for governments and is distinct from individual income tax.

What is corporate tax?

Corporate tax is applied to the net income or profits of a business entity. Net income is calculated by subtracting allowable business expenses, deductions, and credits from the total revenue generated by the company during a specific period.

Corporations can often deduct certain expenses, such as costs associated with producing goods or services, employee wages, interest on loans, and depreciation of assets. These deductions serve to reduce the taxable income, thereby lowering the overall tax liability.

One characteristic of corporate taxation is the potential for double taxation. This occurs when a corporation is taxed on its profits, and then the shareholders are also taxed on any dividends received. 

Governments may offer tax incentives and credits to encourage specific activities or industries. These could include research and development tax credits, incentives for investment in certain regions, or tax breaks for environmentally-friendly practices.

Corporate tax policies can influence investment decisions, job creation, and the overall competitiveness of a country in attracting businesses. High corporate taxes may discourage investment, while low rates can stimulate economic growth.

Example of corporate tax

ABC Corporation is a manufacturing company that operates in a country with a corporate tax rate of 20%. At the end of the fiscal year, ABC Corporation calculates its taxable income.

Let’s say ABC Corporation had a total revenue of $1 million and incurred $600,000 in allowable business expenses, such as manufacturing costs, employee salaries, and other operational expenses. The taxable income would be $1 million – $600,000 = $400,000.

Applying the corporate tax rate of 20%, ABC Corporation would owe $400,000 x 0.20 = $80,000 in corporate taxes. This $ƒ80,000 represents the amount the company is required to pay to the government as its corporate income tax.

Definition

Comparative advantage is an economic principle that describes the ability of a country, individual, or entity to produce a particular good or service at a lower opportunity cost than another.

What is a comparative advantage?

Here’s a breakdown of comparative advantage:

1. Opportunity cost: Refers to the value of what must be foregone in order to choose a particular option. In simpler terms, it’s the benefits or value sacrificed by choosing one alternative over another.
2. Absolute advantage vs. comparative advantage: Absolute advantage refers to the ability of a country or entity to produce a particular good or service with fewer resources (e.g., less labour, capital, or time) than another. Comparative advantage, on the other hand, considers the opportunity cost of producing one good relative to another.
3. Specialisation: The theory of comparative advantage asserts that nations, firms, or individuals should specialise in the production of goods or services in which they have the lowest opportunity cost.
4. Mutually beneficial trade: When countries specialise in producing what they have a comparative advantage in, they can engage in trade with other nations. This leads to mutually beneficial outcomes.
5. Enhances global welfare: The principle of comparative advantage contributes to overall global welfare. It allows resources to be allocated more efficiently across the world, leading to increased total production and a higher standard of living.
6. Long-term economic growth: Embracing comparative advantage fosters economic growth through specialised industries, enabling investment in research, development, and infrastructure for innovation and competitiveness

Comparative advantage is influenced by various factors, including natural resources, technological advancements, labour skills, and capital availability. Changes in these factors can alter a country’s comparative advantage over time.

While comparative advantage provides valuable insights into international trade, it’s not without criticism. Some argue that in practice, factors like imperfect information, transportation costs, and market imperfections can complicate the application of this theory.

Example of comparative advantage

Country A and Country B both have the ability to produce two goods: wheat and cloth.

1. Production capabilities:
   • In a given time period, Country A can produce either 100 units of wheat or 50 units of cloth.
   • Country B can produce either 80 units of wheat or 40 units of cloth.
2. Opportunity costs:
   • The opportunity cost is the value of the next best alternative foregone when a choice is made. Let’s calculate the opportunity costs for both countries:
     • Country A:
       • Opportunity cost of 1 unit of wheat = (50 units of cloth) / (100 units of wheat) = 0.5 units of cloth.
       • Opportunity cost of 1 unit of cloth = (100 units of wheat) / (50 units of cloth) = 2 units of wheat.
     • Country B:
       • Opportunity cost of 1 unit of wheat = (40 units of cloth) / (80 units of wheat) = 0.5 units of cloth.
       • Opportunity cost of 1 unit of cloth = (80 units of wheat) / (40 units of cloth) = 2 units of wheat.
3. Comparative advantage:
   • Both countries have the same opportunity costs for producing wheat and cloth. However, for the sake of illustration, let’s assume that Country A has a slight advantage in cloth production (lower opportunity cost).
4. Specialisation:
   • Recognising their comparative advantages, Country A decides to specialise in cloth production, while Country B specialises in wheat production.

Definition

A cash advance refers to a financial service provided by banks, credit card companies, and some other financial institutions. It allows cardholders or account holders to withdraw a specific amount of money from an ATM or a bank branch using their credit card or debit card.

What is cash advance?

This withdrawal is typically a portion of the cardholder’s credit limit (in the case of a credit card) or a portion of the available balance (in the case of a debit card).

A cash advance provides quick access to cash, which can be useful in situations where physical currency is needed urgently, such as when travelling or during emergencies.

Cash advances usually come with high fees and interest rates. Unlike regular card purchases, which may have a grace period before interest accrues, cash advances often start accumulating interest immediately.

A cash advance is not the same as a loan. It’s essentially a short-term borrowing against the credit limit of a card, and the terms and conditions are specific to the credit card issuer.

Taking a cash advance can lead to debt accumulation if not managed carefully. Due to the high costs associated with cash advances, it’s generally advisable to consider alternative options for obtaining cash, such as using a personal loan or savings.

Some credit cards may have a separate cash advance limit, which may be lower than the overall credit limit. This is an important consideration to be aware of before attempting a cash advance.

Example of cash advance

Sarah is a credit cardholder with a $5,000 credit limit on her card. She has an unexpected expense and needs immediate cash.

1. Cash advance request:
   • Sarah decides to use a cash advance from her credit card. She visits an ATM and requests a cash advance of $500.
2. Cash advance fee:
   • Credit card companies typically charge a cash advance fee, which is a percentage of the total cash advance amount. Let’s say the cash advance fee is 5%.
3. Total amount charged:
   • In addition to the $500 cash advance, Sarah incurs a cash advance fee of 5% on the transaction. The total amount charged to her credit card account is $500 + (0.05 x $500) = $525. 

Definition

Capital refers to the financial resources, assets, or wealth owned or controlled by an individual, business, or entity. It encompasses various forms, including money, property, machinery, investments, and other tangible or intangible assets that hold value.

What is capital?

There are different types of capital, each serving a specific purpose:

1. Financial capital: This includes cash, funds, and other monetary instruments that a business or individual possesses. 
2. Human capital: This refers to the knowledge, skills, expertise, and capabilities of individuals in an organisation. 
3. Physical capital: This encompasses tangible assets like buildings, machinery, equipment, and infrastructure that are used in production or operations.
4. Intellectual capital: This comprises intangible assets such as patents, trademarks, copyrights, and proprietary knowledge.
5. Social capital: This refers to the networks, relationships, and social connections that individuals or organisations have.
6. Natural capital: This encompasses the natural resources and environmental assets that provide value to businesses and society. It includes elements like land, water, minerals, and ecosystems.

Capital plays a crucial role in the functioning and growth of businesses and economies. It allows businesses to invest in new ventures, expand operations, hire employees, and innovate.

Definition

A buyout refers to an individual, group of individuals, or another company purchasing a majority stake in the target entity, giving the buyer substantial control over its operations, decision-making, and future direction. Buyouts can occur for various reasons.

What is a buyout?

Types of buyouts:

1. Management buyout (MBO): In a MBO, the current management team of a company purchases a controlling share from the current owners.
2. Private equity buyout (PEBO): Private equity firms take over a significant share of a company, aiming to improve its performance and eventually sell it for a profit.
3. Leveraged buyout (LBO): In an LBO, a significant portion is financed through debt, often using the assets of the company as collateral. This can enhance the return on investment, but also increase financial risk.
4. Employee buyout (ESOP): Employees of a company acquire a controlling interest in the company.
5. Tender offer: In a tender offer, an entity offers to purchase shares directly from existing shareholders at a specific price.

Prior to a buyout, extensive due diligence is conducted to assess the financial health, legal standing, market position, and potential risks of the target company. This helps to ensure that the purchase is made with full awareness of the entity’s true value and potential challenges.

Buyouts often require a significant amount of capital. After a buyout, the new owners take control of the company and may implement changes in management, operations, and strategy to achieve their specific goals and objectives.

Example of a buyout

ABC Manufacturing is a well-established company in the industrial sector. Its current owners, a group of private equity investors, are looking to exit the business.

XYZ Capital Partners is a private equity firm interested in buying ABC Manufacturing. XYZ believes there is significant potential for operational improvements and cost synergies.

1. Leveraged buyout proposal:
   • XYZ Capital Partners proposes a leveraged buyout to the owners of ABC Manufacturing. The proposal involves buying a significant portion of ABC’s equity using a combination of equity from XYZ and borrowed funds (debt).
2. Use of debt:
   • The use of debt in the buyout is known as leverage. The debt is secured by the assets of ABC Manufacturing, and the company’s future cash flows are expected to cover the debt repayments.
3. Ownership transfer:
   • Upon successful negotiation and agreement, XYZ Capital Partners buys a controlling interest in ABC Manufacturing. The previous owners, the private equity investors, sell their shares, and XYZ becomes the new majority shareholder.
4. Debt Repayment:
   • The cash flows generated by ABC Manufacturing are used to repay the debt incurred during the buyout. The repayment process is structured based on the terms negotiated with the lenders.

Definition

Business-to-consumer (B2C) refers to the type of commerce and business relationship in which companies sell products or provide services directly to individual consumers. In this model, the end customers are the ultimate target market for the goods or services offered. 

What is business-to-consumer?

In a B2C model, businesses market and sell their products or services directly to individual consumers. This can be done through physical storefronts, online marketplaces, or other direct-to-consumer channels.

B2C companies prioritise understanding and meeting the specific needs and preferences of individual consumers. Customer feedback and satisfaction are vital for building brand loyalty, which is crucial for success in this type of commerce.

Example of business-to-consumer

XYZ Electronics is a company that designs and manufactures consumer electronics, including smartphones, laptops, and smart home devices.

1. Customer purchase:
   • A consumer, let’s call her Emily, visits XYZ Electronics’ website, learns about SmartGadget X, and decides to make a purchase. She adds the smartphone to her online shopping cart and completes the transaction by providing her payment details.
2. Delivery to customer:
   • Emily receives the SmartGadget X at her doorstep. The product is exactly as described, and XYZ Electronics includes a user manual and customer support information in the package.

In this B2C example, XYZ Electronics directly sells its consumer electronics product (SmartGadget X) to individual consumers through its online store.

Definition

Business valuation is the assessment of a company’s economic worth, considering factors like assets, liabilities, cash flow, and market position. It’s crucial for decisions in mergers, financial reporting, taxes, estate planning, and potential transactions.

What is business valuation?

Purpose of valuation:

1. Mergers and acquisitions: Businesses may be valued to facilitate buying or selling decisions.
2. Financial reporting: For accounting purposes, companies need to assign a value to their assets and liabilities.
3. Tax planning and compliance: Valuation plays a role in estate planning, gift tax, and other tax-related matters.
4. Litigation and dispute resolution: Valuations may be necessary in legal proceedings, such as shareholder disputes.
5. Fundraising and investments: Investors often require a valuation of a company before deciding to invest.

Methods of valuation:

1. Market approach: This approach compares the subject company to similar businesses that have been sold recently.
2. Income approach: This method evaluates the present value of expected future cash flows or earnings generated by the business.
3. Asset-based approach: This approach focuses on the company’s tangible and intangible assets.

Factors considered in valuation:

1. Financial statements: Income statements, balance sheets, and cash flow statements provide crucial data for valuation.
2. Industry and market conditions: The industry in which the business operates and the overall economic climate can impact its value.
3. Customer base and market share: A loyal customer base and a strong market position can add value.
4. Intellectual property and brand equity: Patents, trademarks, copyrights, and brand recognition can contribute to a business’s worth.

Business valuation is an intricate process and can involve subjective judgments and assumptions. It requires a combination of financial expertise, industry knowledge, and analytical skills. Valuations may need to adhere to specific legal and regulatory standards, especially in cases involving litigation, tax planning, or financial reporting.

If you want to find out what your business is worth, try our business valuation calculator today.

Example of business valuation

1. Financial information:
   • XYZ Tech Solutions is a software development company with consistent annual earnings. The company’s net profit for the most recent year is $500,000.
2. Earnings multiplier:
   • In this example, let’s use an earnings multiplier of 5. The earnings multiplier, also known as the price-to-earnings (P/E) ratio, reflects the perceived risk and growth potential of the business.
3. Valuation Calculation:
   • Valuation = Net profit × Earnings multiplier
   • Valuation = $500,000 × 5 = $2,500,000
4. Interpretation:
   • Based on the earnings multiplier method, the valuation of XYZ Tech Solutions is $2,500,000. This means that, theoretically, a buyer might be willing to pay around $2.5 million for the business, considering its current earnings.