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Glossary of Financial Terms

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Glossary of Financial Terms GLOSSARY OF FINANCIAL TERMS Balance sheet The balance sheet sets out the assets and liabilities of a business and its net worth. Bottom line The closing cash balance, which then becomes the next month’s opening balance and provides the basis for comparison with the firm’s monthly cash-book total. Current assets Assets used or turned over within 12 months: cash in hand or at the bank, debtors and work in progress. Current liabilities Liabilities that need to be met regularly or within the current reporting year. They may include trade creditors, disbursements, bank overdrafts, lease or hire purchase payments and accrued expenses such as annual leave and insurance. Disbursements Client disbursements can be both an income and an expenditure component. Over a period these will be the same, apart from a small net outflow due to growth of the practice and increasing charges. Investing activities This category refers primarily to the cash flow of sales and purchases of assets relating to the business. An example of an inflow of revenue from an investing activity is the sale of an office, property or equipment. An outflow would be the purchase of such assets. Fees or income Cost basis when fees paid for legal services. Accruals when invoice raised for legal service. Financing activities This category relates to such things as the borrowing and repaying of loans, and returning investments to investors. Financial performance statement Also known as a profit and loss statement; shows all income and expense accounts over time while indicating profitability over the same period. The main items shown on a financial performance statement for a legal practice are: fees or income operating expenses net profit before tax provision for income tax net profit after tax. Net profit after tax The net profit after tax is the figure remaining after income tax liability is subtracted from the net profit before tax. Net profit before tax: Net profit before tax is the difference between sales revenue and operating expenses (operating expenses being subtracted from sales revenue). However if the practice receives revenue from sources other than sales, that income is added to the net profit before tax. Non-cash expenditure Non-cash expenditure items tabled in the profit and loss budget, such as the provision for bad debt and depreciation, should be subtracted from expenditure when calculating cash outflow. Non-current (fixed) assets Assets used or turned over in more than 12 months. They include office space and equipment that is not leased and freehold premises. Non-current (deferred) liabilities Debts or repayments to creditors that run beyond the reporting year, such as long-term loans. They include long- term loans and accruing expenses to be met beyond the next 12 months, such as long service leave. Operating activities This amount relates to the cash flow of the practice’s main revenue stream. Inflows for law practices would primarily be legal fees. Outflows would include payments to suppliers and employees, and tax liabilities. Operating expenses Operating expenses are the amounts spent to run the practice. The expenses listed under this heading should at least match the expected expenses listed in the annual profit and loss budget and cash flow budget. Provision for income tax This figure relates to the amount of income tax to be paid on the net profit before tax. Many factors affect the taxation amount, such as the business structure of the practice. Quick asset ratio This ratio is designed to show the value of assets convertible into cash without an appreciable drop in value. It uses current assets and current liabilities, but excludes whatever cannot be converted into cash. The formulae sequence is as follows: Quick assets = Current assets - (inventory + repayments + bank interest) Quick liabilities = Current liabilities - bank overdraft The quick assets figure is then divided by the quick liabilities figure to give a dollar amount. Shortfall When the outflow is more than the inflow, the result is a shortfall. A firm may resort to a short term cash injection from a bank to cover this shortfall. Statement of cash flows Shows how much of the cash generated by the business remains after expenses incurred for operating activities, investing activities and financing activities. Working capital ratio This ratio, also known as the current asset ratio, measures the level of liquidity of a business by showing how many dollars of current assets are available to meet each dollar of current liability. This is done by dividing the level of current assets by the level of current liabilities. For example, a practice may have current assets of $500,000 and liabilities of $200,000. The liabilities go into the assets 2.5 times, so the practice has $2.50 in assets to cover each dollar of liability. .
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