1 supplemental materials for micro-enterprise credential teachers fundamental financial vocabulary...

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Supplemental Materials for Micro-Enterprise Credential Teachers

Fundamental Financial

Vocabulary

Send questions or requests for clarification to [email protected]

mailto:[email protected]

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Accounting Terms Definitions (1 of 6)Accounting Period

A month, a quarter or a fiscal year. Any period for which a financial statement is prepared

Asset A thing of value. Asset examples: a) buildings; b) cash; c) bills you’ve sent to a good customer that haven’t been paid yet (called “accounts receivable”)

Amortize To spread a non-recurring expenditure over a period of years. Three terms are used to communicate this same concept: depreciation, depletion, amortization• Assets are depreciated• “Goodwill” is amortized• Natural resources are depleted

Fundamental Financial Concepts

Basis The original cost of an asset is its basis. For example, your basis in your car is the amount you originally paid to buy that car, plus any additional expenditures directly related to putting that car into service

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Accounting Terms Definitions (2 of 6)

Balance Sheet Terms

Asset – thing of value

Liability – a debt or obligation owed to an outsider

Equity – the amount contributed by owners to an enterprise


A balance sheet is a house

Asset: the House Liability: the mortgage

Down Paymentor Equity

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Balance Sheet

The accounting statement that indicates the assets, liabilities and net worth of an enterprise at a moment in time. The balance sheet is the “anatomy” of a business, indicating the assets owned by the company, the amounts due to outsiders and the value owned by insidersA balance sheet is a snapshot of a business frozen at a moment in time


Depreciation The theoretical reduction in value of an asset over time. “Net basis” or “net asset value” is the basis of an asset less its accumulated depreciation. (“Net” always means: subtract something!)

What is the relationship between an asset’s net basis and its actual market value? Absolutely none!!!

Book Value

Book Value is defined as Assets minus Liabilities (usually applied to a business)

Net Worth is defined as Assets minus Liabilities (usually applied to a person)

Equity is defined as Assets minus LiabilitiesThree terms that mean the same thing. Why?

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Revenues Units Sold x Price (may or may not equal the amount of cash received by the enterprise)

Cost of Goods Sold

The cost of what the enterprise sells (direct materials and labor). At a department store COGs = the cost paid to buy the clothes it sells

Gross Margin

The amount left over when you subtract your cost of goods sold from your revenue; the amount you have to spend on “everything else”

Income Statement

The accounting statement that shows how well an enterprise did in terms of earning money, usually by quarter (3 months) or one year

Operating Expenses

The money spent to operate and maintain an enterprise. Many enterprises use the term O&M or “Operating and Maintenance” expense

EBITDA “Earnings before Interest, Taxes, Depreciation and Amortization” – the net after all non-banking cash expenses are subtracted from revenues

Interest The money paid as consideration for liabilities incurred

PBT Profit Before Taxes

Taxes Taxes paid

PAT Profit After Taxes

Dividends The money (if any) paid to shareholders after all expenses

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Income Statements

versus Balance Sheets:

Useful analogies

A balance sheet is ice – a snapshot of a business frozen in time

An income statement is water – the cash that flows through a business over the course of an accounting period

To Expense is to flow an expenditure through an income statement

To Capitalize is to freeze an expenditure and put it on a balance sheet

Depreciation is the ice that melts off a capitalized expenditure


There are very real and important tax and cash flow consequences based on whether you capitalize or expense an expenditure.

Those are more complex considerations best left for another time.

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Accounting Terms Definitions (6 of 6)Historical Cost

All dollar amounts on a financial statement are recorded at historical cost. A building purchased in downtown New York for $23,000 in 1930 will be recorded at historical cost (net of accumulated depreciation) – maybe $0 – when its market value may be in the millions.

Objectivity Why do accountants use historical cost instead of market value on a balance sheet if they know historical cost is “wrong?” Because historical cost is objective – it has a value we can confirm.

Market Value What the next sucker coming down the pike will pay for that asset you have to sell.What is the relationship between net historical cost and market value? None!


Material Material means “big enough to care about.” Materiality is relevant to the size and scope of the enterprise.

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How Costs “Behave”Fixed Costs Fixed costs are incurred at the beginning of an endeavor. They are

incurred “all at once” and don’t vary with activity. The key issue is: “How big do you build it.” Example: New school building

Semi-Variable Costs

Exactly what it sounds like – costs that vary somewhat with the level of activity. Example: new computers for the kids might be a semi-variable cost if: a) the hardware must be purchased; but b) the school has a site license for the software so there’s no charge for a new user

Variable Costs

Variable costs vary with the level of activity. Books and learning materials are variable costs, because every time you add a student he/she needs books, a computer and other learning materials


Step Function Cost

“Peanuts ain’t filling, but you can’t eat a billion of them.” Some costs can remain fixed only so long, until you need to make a major expenditure to account for the next unit of activity. Examples: hiring a new teacher when a class gets too crowded, or building a new building

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Which Costs Behave How?


Salaries and Benefits

Step Function or Variable

Step function when adding a new teacher (you can always shoe-horn in another kid into the class . . . until you can’t).Variable if you’re hiring contract labor (substitute teachers . . . or online course seats!)

Average cost is never a good cost measure to use

Marginal Cost The cost of producing / adding the next “unit.” Many people define marginal cost as variable cost, but as you can see this is not always true given “semi-variable” costs and “step function” costs

O&M Expenses Fixed or Semi-Variable

Utilities really won’t change because another kid sits in the class. But at some point more kids cause more wear and tear on the facility, which will cause at least some level of increased need for maintenance work

Transportation Step Function or Variable

Step function if you’re running your own bussesVariable if you’re buying seats from a bus company

Learning Materials Variable Variable (with some potential for being semi-variable as noted

before)

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Additional Pricing Concepts


Marginal Pricing

Pricing a good or service based on the cost of the next unit of production. Aggressive organizations will find ways to lower marginal prices (e.g., stipends, discounts, coupons) to lower the net effective price to customers for whom the associated marginal costs-to-serve are low

Dynamic Pricing

Changing prices in real time as buying patterns change the marginal value of the item being sold. Example: once you start selling airplane seats or concert tickets and remaining seats get scarce, raise the price! (Or lower the price of bleacher tickets that aren’t selling, raise the price of front row seats that are)

Value-Based Pricing

Pricing based on the value perceived or received, rather than cost.Why did we charge $2.50 per Koosh Ball when it cost us about 11¢ to make one? Because we could!

Postage Stamp Pricing

Flat pricing for all items. Benefit: simplicity. Flaw: encourages competitors to poach customers with low marginal costs-to-serve by offering aggressive net marginal prices!

If you “get” this – you graduate summa cum laude!

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