Definition

A balance sheet is a financial statement that provides a snapshot of a company’s financial position at a specific point in time. It presents a summary of the company’s assets, liabilities, and shareholders’ equity, showing how these elements are balanced or equal.

What is a balance sheet?

Here’s a breakdown of the components found on a balance sheet:

1. Assets: These are the resources owned by the company that have economic value. Assets are typically categorised into current assets (those that are expected to be converted into cash or used up within a year) and non-current assets (those with a longer lifespan). Examples of assets include cash, accounts receivable, inventory, property, equipment, and investments.
2. Liabilities: These are the company’s obligations or debts to external parties. Similar to assets, liabilities are divided into current liabilities (debts due within a year) and non-current liabilities (long-term debts). Examples of liabilities include accounts payable, loans, bonds, and other forms of debt.
3. Shareholders’ equity: Also known as owners’ equity or net worth, this represents the residual interest in the company’s assets after deducting its liabilities. It includes the initial investment by the shareholders plus any retained earnings generated by the company’s operations.

The balance sheet follows the fundamental accounting equation: Assets = liabilities + shareholders’ equity. This equation ensures that the company’s resources (assets) are financed by either external sources (liabilities) or internal sources (shareholders’ equity).

Balance sheets are essential financial documents used by investors, analysts, creditors, and management to assess a company’s financial health, liquidity, and overall stability. By analysing the relationships between assets, liabilities, and equity, stakeholders can gain insights into a company’s ability to meet its financial obligations and fund its operations.

Example of a balance sheet

This example provides a simplified representation, and actual balance sheets for companies may have additional details and notes.

Definition

Capital gains refer to the profits or returns earned from the sale or disposition of a capital asset. A capital asset can include various types of property, such as stocks, real estate, bonds, precious metals, and other investments.

What is capital gains?

When you sell a capital asset for a price higher than its original purchase price, the difference between the selling price and the purchase price is considered a capital gain. Capital gains can be either short-term or long-term, depending on the holding period of the asset:

1. Short-term capital gains: If you hold the asset for one year or less before selling it, any profit from the sale is classified as a short-term capital gain. Short-term capital gains are typically taxed at a higher rate than long-term gains.
2. Long-term capital gains: If you hold the asset for more than one year before selling it, the resulting profit is considered a long-term capital gain. Long-term capital gains often receive preferential tax treatment, with lower tax rates compared to short-term gains.

Capital gains are an important aspect of investment income and are subject to taxation in many countries. The tax implications of capital gains vary based on factors such as the type of asset, the duration of ownership, and the tax regulations of the specific jurisdiction.

Example of capital gains

John, an individual investor, purchases 100 shares of XYZ Company’s stock at N$50 per share. His total investment is N$5,000.

1. Stock appreciation:
   • Over time, the value of XYZ Company’s stock increases due to strong financial performance and market demand. The current market price per share rises to N$70.
2. Decision to sell:
   • Recognising the opportunity to profit, John decides to sell his 100 shares of XYZ Company’s stock at the current market price of N$70 per share.
3. Calculation of capital gains:
   • John’s initial investment was N$5,000 (100 shares x N$50 per share). The proceeds from the sale amount to N$7,000 (100 shares x N$70 per share). His capital gain is calculated as follows:Capital gain = Selling price – Purchase price$\text{Capital gain}=\; N\$7,000\; –\; N\$5,000\; =\; N\$2,000$

After accounting for any applicable taxes, John’s net capital gain is the profit he retains from the sales of the stock.

Definition

Cash flow refers to the movement of money into and out of a business or individual’s financial accounts over a specific period of time. It represents the net amount of cash generated or consumed by various financial activities, such as operating, investing, and financing activities.

What is cash flow?

There are three main components of cash flow:

1. Operating cash flow: This represents the cash generated or used by a company’s core business operations. It includes revenues from sales and services minus operating expenses like salaries, rent, and other operational costs. Operating cash flow is a key indicator of a company’s ability to generate cash from its primary activities.

2. Investing cash flow: This component reflects the cash inflows and outflows related to investments in assets or the sale of assets. It includes cash spent on purchasing new equipment, property, or other investments, as well as cash received from the sale of these assets.

3. Financing cash flow: Financing cash flow accounts for the movement of cash resulting from borrowing or repaying loans, issuing or buying back stocks, and paying dividends. It shows how a company raises and distributes funds to investors and creditors.

Positive cash flow indicates that a business or individual receives more cash than they are spending, which is generally considered a healthy financial state. Negative cash flow, on the other hand, indicates that more money is going out than coming in, which could lead to financial difficulties if sustained over time.

Do you want to know whether your cash flow is positive or negative? Try our cash flow calculator and find out.

Cash flow analysis is crucial for assessing a business’s financial health and sustainability. It helps to determine whether a company can meet its financial obligations, invest in growth opportunities, and cover day-to-day expenses.

Example of cash flow

Sarah owns a small boutique that sells clothing and accessories. The business operates in a brick-and-mortar store and accepts both cash and credit card payments. On a typical day, Sarah’s Boutique makes sales totalling N$1,000. Customers pay using a mix of cash and credit cards.

1. Cash payment:
   • Of the N$1,000 in sales, N$300 are paid in cash by customers at the store. This cash immediately becomes part of the business’s cash flow.
2. Credit card payments:
   • The remaining N$700 is paid by customers using credit cards. While this contributes to revenue, the actual cash from credit card transactions is not immediately received. It will be received later when the credit card payments are processed by the payment processor and deposited into the business’s bank account.
3. Operating expenses:
   • Throughout the day, Sarah incurs various operating expenses, including purchasing inventory, paying utilities, and covering employee wages. These expenses may be paid in cash, checks, or electronically, depending on the vendor.
4. Cash outflows:
   • Let’s say Sarah pays N$400 in cash for inventory and N$200 in cash for other daily expenses. These cash outflows reduce the available cash in the business.
5. End-of-day cash flow:
   • At the end of the day, Sarah’s Boutique has a net positive cash flow of N$300 (cash sales) – N$400 (cash expenses) = -N$100. While the net cash flow for the day is negative, it doesn’t necessarily indicate financial distress; it could be part of normal business operations.

Definition

Collateral refers to assets or property that a borrower pledges to a lender as a security for a loan.

What is collateral?

This serves as a guarantee for the lender that if the borrower is unable to repay the loan, the lender can seise and sell the collateral to recover the borrowed amount.

Collateral can take various forms, such as real estate, vehicles, equipment, inventory, or even financial assets like stocks or bonds. It provides a level of assurance for lenders and allows borrowers to access loans they might not otherwise qualify for.

Example of using collateral

Sarah wants to purchase a car and decides to finance the purchase through a bank loan. ABC Bank agrees to provide Sarah with a secured car loan.

1. Loan amount:
   • Sarah needs N$20,000 to buy the car. ABC Bank approves the loan and provides her with the funds.
2. Collateral:
   • To secure the loan, Sarah pledges the car she intends to purchase as collateral. The car’s value is estimated at N$25,000.
3. Use of funds:
   • Sarah uses the N$20,000 loan from ABC Bank to purchase the car.
4. Ownership and collateral agreement:
   • As part of the loan agreement, ABC Bank places a lien on the car, meaning that until Sarah repays the loan, the bank has a legal claim to the car.
5. Repayment:
   • Over the loan term, Sarah makes monthly payments to ABC Bank, covering both the principal amount borrowed and the accrued interest.

If Sarah fails to make the agreed-upon payments and defaults on the loan, ABC Bank has the right to take possession of the car, sell it, and use the proceeds to recover the outstanding loan balance.

Definition

Cost of capital refers to the total cost a company incurs in order to raise funds for its operations and investments. It represents the overall expense of utilising various sources of financing, such as equity (stocks) and debt (loans or bonds), to support the company’s activities.

What is cost of capital?

The cost of capital takes into account both the cost of equity and the cost of debt. The cost of equity is the return that shareholders expect for investing in the company’s stock, taking into consideration factors like dividends and potential capital gains. The cost of debt, on the other hand, is the interest expense a company pays on its borrowed funds.

Calculating the cost of capital helps a company make informed decisions about which projects or investments to undertake. It serves as a benchmark to assess whether the potential returns from an investment are greater than the cost of obtaining the necessary funds. This analysis is crucial for maintaining profitability and shareholder value.

For businesses, understanding the cost of capital is essential for strategic planning, capital budgeting, and evaluating the financial viability of various opportunities. It’s a fundamental concept in corporate finance that plays a pivotal role in shaping a company’s financial decisions.

Example of cost of capital

Definition

An exchange-traded fund (ETF) is a type of investment fund that is traded on stock exchanges, similar to individual stocks.

What is an exchange-traded fund?

This is designed to track the performance of a specific index, sector, commodity, or asset class. ETFs offer investors a convenient way to gain exposure to a diversified portfolio of assets without directly owning each individual asset.

ETFs can contain a mix of stocks, bonds, commodities, or other assets, and their value fluctuates throughout the trading day as they are bought and sold on the exchange. They provide investors with an opportunity to invest in a broad market or a specific investment theme without having to buy and manage the underlying assets themselves.

One of the key advantages of ETFs is their liquidity and flexibility – they can be bought or sold at any point during trading hours, and their prices are updated in real time. Additionally, ETFs often have lower fees compared to traditional mutual funds.

In summary, an ETF is a type of investment vehicle that combines the characteristics of a stock and a mutual fund, offering investors a way to diversify their portfolio and gain exposure to various markets or assets with relative ease.

Example of exchange-traded fund

Consider the “ABC Technology ETF,” which is an ETF that aims to track the performance of a technology stock index. This ETF may hold a diversified portfolio of technology stocks. Investors can buy and sell shares of the ABC Technology ETF on a stock exchange throughout the trading day, just like individual stocks.

Investors who buy shares in the ABC Technology ETF effectively gain exposure to the overall performance of the technology sector without having to buy each individual stock separately. ETFs provide a convenient and cost-effective way for investors to diversify their portfolios and gain exposure to specific sectors, industries, or asset classes.

Defintion

An expense ratio, in financial terms, refers to the percentage of a mutual fund or an exchange-traded fund’s (ETF) assets that are used to cover the fund’s operating expenses.

What is an expense ratio?

These operating expenses include various costs associated with managing and administering the fund, such as management fees, administrative fees, custodian fees, marketing expenses, and other operational costs.

The expense ratio is expressed as a percentage and is calculated by dividing the total expenses of the fund by its average assets under management (AUM) over a specific period, usually a year. This ratio is important for investors because it reflects the proportion of their investment that goes towards covering the fund’s ongoing costs.

A lower expense ratio is generally preferred by investors, as it means a larger portion of their investment is working to generate returns rather than being used to cover expenses. Expense ratios can vary significantly between different funds and investment products, so it’s important for investors to consider this factor when choosing where to invest their money.

Example of expense ratio

Definition

An exponential moving average (EMA) is a widely used technical analysis tool in the field of finance. It’s a type of moving average that gives more weight to recent price data, making it more responsive to recent price changes compared to a simple moving average (SMA).

What is exponential moving average?

In essence, the EMA emphasises recent trends and price movements. To calculate the EMA, you start with a given period of price data (for example, a certain number of days or time intervals). The EMA places more weight on the most recent prices while factoring in older prices as well. This is achieved through a mathematical formula that incorporates a smoothing factor.

As a result, the EMA tends to react more quickly to sudden price changes, making it useful for identifying short-term trends and potential trading opportunities. Traders and analysts often use EMAs in combination with other technical indicators to make informed decisions about buying or selling financial instruments like stocks, currencies, or commodities.

In summary, the exponential moving average (EMA) is a tool that helps traders and analysts assess recent price trends and potential market movements by giving more weight to recent data points. It’s a valuable tool in technical analysis for understanding short-term price dynamics.​

Definition

A financial statement is a formal record of a company’s financial activities and position. It provides a snapshot of the company’s financial performance and health over a specific period, usually a quarter or a year.

What are financial statements?

Financial statements are essential tools for assessing a company’s financial status, making informed investment decisions, and evaluating its overall viability.

There are three primary types of financial statements:

1. Income statement (profit and loss statement): This statement summarises a company’s revenues, expenses, and profits (or losses) over a given period. It shows how much money the company generated from its operations and the costs incurred to generate that revenue. The difference between total revenue and total expenses yields the net income (or net loss) for the period.

2. Balance sheet (statement of financial position): The balance sheet provides a snapshot of a company’s financial position at a specific point in time. It lists the company’s assets (what it owns), liabilities (what it owes), and shareholders’ equity (the residual interest in the company’s assets after deducting liabilities). The balance sheet follows the fundamental accounting equation: Assets = Liabilities + Shareholders’ Equity.

3. Cash flow statement: This statement details the inflows and outflows of cash and cash equivalents during a specified period. It categorises cash flows into operating activities (day-to-day business operations), investing activities (acquiring or disposing of assets), and financing activities (raising capital or repaying debt). The cash flow statement provides insights into a company’s liquidity and cash management.

Financial statements are crucial for investors, creditors, regulators, and management to assess a company’s financial performance, make informed decisions, and ensure compliance with financial reporting standards. They offer a comprehensive view of a company’s financial health, its ability to generate profits and cash flow, and its overall stability.

Example of financial statement

A financial statement typically includes three main components: the income statement, the balance sheet, and the cash flow statement. Here’s a simplified example of each:

Income Statement:

In this example, the company earned N$100,000 in revenue and incurred N$70,000 in expenses, resulting in a net income of N$30,000.

Balance sheet

This balance sheet shows the company’s assets (cash, inventory, equipment) and how they are financed through liabilities (loans) and owner’s equity.

Cash flow statement

This cash flow statement summarises how cash is generated and used in different business activities, including operations, investments, and financing.

These statements provide a snapshot of a company’s financial health and performance during a specific period. Keep in mind that real financial statements are more detailed and may include additional line items and notes.

Definition

A fiscal year, often abbreviated as “FY,” is a 12-month period that a company or organisation uses for financial reporting and planning purposes. Unlike the calendar year, which begins on January 1st and ends on December 31st, a fiscal year can start on any date and end 12 months later.The choice of when the fiscal year starts and ends is typically based on the company’s operational and reporting needs.

What is a fiscal year?

A company’s fiscal year may align with the calendar year, running from January 1st to December 31st. However, many companies choose different fiscal year start dates, such as April 1st to March 31st or July 1st to June 30th. Government entities, nonprofits, and businesses in various industries might opt for fiscal years that correspond to their specific business cycles.

The use of a fiscal year allows organisations to track financial performance, create budgets, and report results without being confined to the calendar year. This can be especially important for businesses that experience seasonal fluctuations in their operations or for those whose accounting needs differ from traditional calendar periods.

In summary, a fiscal year is a 12-month period chosen by a company or organisation for financial reporting and planning, providing flexibility to align with their operational patterns and financial requirements.

Example of a fiscal year

Company XYZ, a retail company, has chosen a fiscal year that runs from April 1 to March 31.

During this fiscal year, the company conducts its business operations, generates revenue, incurs expenses, and engages in financial activities. At the end of the fiscal year on March 31 the company’s financial statements are prepared to provide a summary of its financial performance and position during this period.

Definition

Fixed income, in financial terms, refers to an investment category characterised by regular and predictable payments of interest or income over a specified period.

What is fixed income?

Fixed income is often associated with investments like bonds and other debt securities issued by governments, municipalities, corporations, and other entities.

The term “fixed income” originates from the fact that these investments offer a fixed interest rate or coupon payment to investors at regular intervals, typically semiannually or annually. The interest payments remain constant throughout the life of the investment, regardless of changes in market conditions.

Bonds are the most common type of fixed-income investment. When an investor buys a bond, they are essentially lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity. The interest rate offered by the bond is predetermined and provides investors with a predictable income stream.

Fixed-income investments are often favoured by those seeking stable and relatively low-risk returns. They are considered less volatile compared to other investments like stocks, making them attractive to risk-averse investors and those looking to preserve capital. However, it’s important to note that while fixed-income investments offer stability, they may have a lower potential for capital appreciation compared to higher-risk assets.

In summary, fixed income refers to investments that provide a predictable stream of income through regular interest payments, commonly associated with bonds and debt securities. It offers stability and is commonly chosen by investors seeking steady returns and income.

Example of fixed income

Definition

A forward contract is a financial agreement between two parties to buy or sell a specific asset, such as commodities, currencies, or financial instruments, at a predetermined price on a future date.

What is a forward contract?

A forward contract is a type of derivative contract where the terms, including the price and delivery date, are established at the outset of the agreement. Forward contracts are commonly used to hedge against price fluctuations or to speculate on future price movements.

The key features of a forward contract are:

1. Customisation: Forward contracts are customisable to meet the specific needs of the parties involved. They can be tailored in terms of the asset being traded, the contract sise, the delivery date, and the agreed-upon price.

2. Private agreement: Forward contracts are private agreements negotiated directly between the parties. They are not traded on exchanges, which means the terms are not standardised and can vary between contracts.

3. Obligation to fulfill: Both parties are legally obligated to fulfil the terms of the contract at the agreed-upon future date. This means the buyer must buy and the seller must sell the asset at the specified price, regardless of market conditions at that time.

Regarding regulation, the level of regulation for forward contracts can vary depending on the jurisdiction, the type of asset involved, and the parties engaged in the transaction. In some cases, forward contracts may not be as heavily regulated as other financial derivatives like futures contracts. However, regulations surrounding derivatives have evolved over time, particularly in response to financial crises and the need for transparency and risk mitigation.

In many countries, financial authorities have implemented regulations to ensure fair practices, mitigate risks, and promote market stability. For instance, derivatives markets may be subject to oversight by financial regulatory agencies. Additionally, depending on the nature of the underlying asset, specific regulations may apply to certain types of forward contracts.

It’s important to note that while forward contracts offer flexibility and customisation, they also carry risks, such as counterparty risk (the risk that the other party may not fulfil its obligations) and price risk (the risk that the market price at the contract’s maturity is unfavourable). Traders and businesses should carefully consider these risks and the regulatory framework in their jurisdiction before engaging in forward contract transactions.

Example of forward contract

Company ABC, based in the US, is expecting to receive €1,000,000 from a European client in three months. To hedge against the risk of currency exchange rate fluctuations, ABC enters into a forward contract with a financial institution.

• Current exchange rate: 1 USD = 0.85 EUR
• Forward contract agreement: ABC agrees to exchange €1,000,000 for $1,200,000 in three months.

At the end of three months, regardless of the prevailing exchange rate, ABC is obligated to exchange €1,000,000 for $1,200,000. If the exchange rate at that time is favourable (e.g., 1 USD = 0.80 EUR), ABC still exchanges €1,000,000 for $1,200,000, gaining a currency advantage.

Conversely, if the exchange rate becomes less favourable (e.g., 1 USD = 0.90 EUR), ABC still exchanges €1,000,000 for $1,200,000, but avoids the potential loss associated with the deteriorating exchange rate.

In this example, the forward contract helps Company ABC manage the risk associated with currency fluctuations, providing certainty about the amount of dollars they will receive in exchange for euros at a future date.