CAPITALThis is a very broad term with its roots in economic theory that refers to money and other assets that are invested in a business or other venture for the general purpose of earning a profit, or a return on the investment. Generally speaking, the sources of capital to a business are divided between debt and equity. Debt, as you probably know, is borrowed money on which interest is paid. Equity is the broad term for the ownership capital invested in a business, and most often is called owners’ equity. Owners’ equity arises from two quite different sources: money or other assets invested in the business by its owners, and profit earned by the business that is retained and not distributed to its owners [which is called retained earnings].


CAPITAL BUDGETING – This term refers generally to analysis procedures for comparing alternative investments given a limited amount of total capital that has to be allocated among the various capital investment opportunities of a business. The term sometimes is used interchangeably with the analysis techniques themselves, such as calculating present value, net present value, and the internal rate of return of investments.


CAPITAL EXPENDITURES – This term refers to investments by a business in long-term operating assets, including land and buildings, heavy machinery and equipment, vehicles, tools, and other economic resources used in the operations of a business. The term capital is used to emphasize that these are relatively large amounts and that a business has to raise capital for these expenditures from debt and equity sources.

CAPITAL INVESTMENT ANALYSIS – This term refers to several techniques and methods for analyzing the future returns from an investment of capital in order to evaluate the periodic capital recovery and earnings from the investment. The two broad approaches for capital investment analysis are spreadsheet models and mathematical equations for calculating the present value and internal rate of return of an investment. Determining the present value of an investment is also referred to as the discounted cash flow technique.


CAPITAL STOCK – These are ownership shares issued by a business corporation. A business corporation may issue more than one class of capital stock shares. One class may have voting privileges in the election of the directors of the corporation, and the other class may not. One class [called preferred stock] may be entitled to a certain amount of dividends per share before cash dividends can be paid on the other class [usually called common stock]. Stock shares may have a minimum amount for which they have to be issued [called the par value], or stock shares can be issued for any amount [called no par stock]. Stock shares may be traded on public markets, such as the New York Stock Exchange, or through the Nasdaq network. There are about 10,000 stocks traded on public markets [although estimates vary for this number].

CAPITAL STRUCTURE, OR CAPITALIZATION – These terms refer to the combination of capital sources that a business has tapped for the money to invest in its assets—in particular the mix of its interest-bearing debt and its owners’ equity. In a more sweeping sense, the terms also include appendages and other features of the basic debt and equity instruments of a business. Such things as stock options, stock warrants, and convertible features of preferred stock and notes payable are included in the broader sense of the terms, as well as any debt-based and equity-based financial derivatives issued by the business.


CAPITALIZATION OF COSTS – When a cost is originally recorded as an increase in an asset account, it is said to be capitalized. This means that the outlay is treated as a capital expenditure, which becomes part of the total cost basis of the asset. The alternative is to immediately record the cost as an expense in the period the cost is incurred. Capitalized costs refer mainly to costs that are recorded in the long-term operating assets of a business, such as buildings, machines, equipment, tools, and vehicles.

CASH BURN RATE – A relatively recent term that has come into use; it refers to how fast a business is using up its available cash, especially when its cash flow from operating activities is negative instead of positive. This term most often refers to a business struggling through its start-up or its early phases that has not yet generated enough cash inflow from sales to cover its cash outflow for expenses [and perhaps never will].


CASH FLOW – This term is obvious but at the same time elusive. The term obviously refers to cash inflows and outflows during a period. But the specific sources and uses of cash flows are not clear in this general term. The statement of cash flows, which is one of the three primary financial statements of a business, classifies cash flows into three types: [1] from operating activities [sales and expenses, or profit-making operations], [2] from investing activities, and [3] from financing activities. Sometimes, the term cash flow is used as shorthand for cash flow from profit [i.e., cash flow from operating activities].

CASH FLOW FROM OPERATING ACTIVITIES [also called cash flow from profit and operating cash flow] – This equals the cash inflow from sales during the period minus the cash outflows for expenses during the period. According to generally accepted accounting principles [GAAP], a business must use accrual-basis accounting to measure its net income [i.e., to record its revenue and expenses]. At the same time, a business is required by GAAP to present a statement of cash flows that includes the amount of cash flow from operating activities. Accountants don’t like to admit it, but this cash flow amount equals what profit would be on the cash basis of accounting. So, you get both the accrual-basis profit number and the cash-basis profit number in a financial report. One important reason that the accrual-basis number is more correct and realistic is because it deducts an expense for the depreciation of the company’s fixed assets. You can’t ignore the fact that a business’s fixed assets wear out and lose their economic usefulness over time.


CASH FLOWS, STATEMENT OF –  This is one of the three primary financial statements that a business includes in the periodic financial reports to its outside shareowners and lenders. This financial statement summarizes the business’s cash inflows and outflows for the period according to a threefold classification: [1] cash flow from operating [profit-making] activities; [2] cash flow from investing activities; and [3] cash flow from financing activities. Warning: The typical statement of cash flows is difficult to decipher; it includes too many lines of information and is overly technical compared with a typical balance sheet and income statement.

CONTRIBUTION MARGIN – This is an intermediate measure of profit that is equal to sales revenue minus cost of goods sold expense and minus variable operating expenses—but before fixed operating expenses are deducted. Profit at this point contributes toward covering fixed operating expenses and toward interest and income tax expenses. The breakeven point is the sales volume at which contribution margin just equals total fixed expenses.


CONVERSION COST – This term refers to the sum of direct labor and production overhead costs of manufacturing products. The cost of raw materials used to make products is not included in this definition. Generally speaking, this is a rough measure of the value added by the manufacturing process.

COST OF CAPITAL – This refers to the interest cost of debt capital used by a business plus the amount of profit that the business should earn for its equity sources of capital to justify the use of the equity capital during the period. Interest is a contractual and definite amount for a period, whereas the profit that a business should earn on the equity capital employed during the period is not. A business should set a definite goal of earning at least a certain minimum return on equity [ROE] and should compare its actual performance for the period against this goal. The costs of debt and equity capital are combined, or weighted, into either a before-tax rate or an after-tax rate for capital investment analysis.


CURRENT ASSETS – The term current refers to cash and those assets that will be turned into cash in the short run. Five types of assets are classified as current: cash, short-term marketable investments, accounts receivable, inventories, and prepaid expenses [and they are generally listed in this order in the balance sheet].

CURRENT LIABILITIES – The term current refers to the liabilities that come due and will be paid in the near term, which generally means one year or less. In most cases these include accounts payable, accrued expenses payable, income tax payable, short-term notes payable, and the portion of long-term debt that will come due during the coming year. Keep in mind that a business may roll over its liabilities; the maturing liabilities are normally replaced in part or in whole by new liabilities that take the place of the old liabilities.


CURRENT RATIO – This ratio is calculated to assess the short-term solvency, or debt-paying ability, of a business. It equals total current assets divided by total current liabilities. Some businesses remain solvent with a relatively low current ratio, and others could be in trouble with an apparently good current ratio. The general rule is that the current ratio should be 2:1 or higher, but current ratios vary widely from industry to industry.

DEBT-TO-EQUITY RATIO – This is a widely used financial statement ratio to assess the overall debt load of a business and its capital structure. It equals total liabilities divided by total owners’ equity. Both numbers for this ratio are taken from a business’s latest balance sheet. There is no standard or generally agreed benchmark ratio, such as 1:1 or 2:1. Every industry is different in this regard. Some businesses, in particular banks and other financial institutions, have very high debt-to-equity ratios, whereas other businesses use very little debt relative to their owners’ equity.


DEFERRED MAINTENANCE – This term refers to decisions by managers to put off, or delay, making expenditures for the normal repair and maintenance of a company’s assets, such as not painting a building or not servicing the company’s boiler until the following year. The term implies that this is done to massage the numbers, that is, to avoid recording the expense this year in order to report a higher profit for the year.

DEPRECIATION – This term refers to the generally accepted accounting principle of allocating the cost of a long-term operating asset over the estimated useful life of the asset. Each year of use is allocated a fraction of the original cost of the asset. Generally speaking, either the accelerated method or the straight-line method of depreciation is used. [There are other methods, but they are not as common.] Useful-life estimates are heavily influenced by the schedules allowed in the federal income tax law. Depreciation is not a cash outlay in the period the expense is recorded—just the opposite. The cash inflow from sales revenue during the period includes an embedded amount that reimburses the business for the use of its fixed assets. In this respect, depreciation is a source of cash.


DILUTED EARNINGS PER SHARE [EPS] – This measure of earnings per share recognizes that additional stock shares may be issued in the future for stock options and may be required by other contracts in which a business has entered, such as convertible features in its debt securities and preferred stock. Both basic earnings per share and, if applicable, diluted earnings per share are reported by publicly owned business corporations. Often the two EPS figures are not far apart; but in some cases the gap is significant. Privately owned businesses do not have to report earnings per share. See also basic earnings per share discounted cash flow [DCF] This term refers to a capital investment analysis technique that discounts, or scales-down, the future cash returns from an investment. The discount rate is based on the cost of capital for the business. In essence, each future return is downsized to take into account the cost of capital from the start of the investment until the future point in time when the return is received. Present value [PV] is the amount resulting from discounting the future returns. The entry cost is subtracted from present value of the investment to determine net present value [NPV]. The net present value is positive if the present value is more than the entry cost, which signals that the investment would earn more than the cost of capital rate. Conversely, if the entry cost is more than the present value, the net present value is negative, which means that the investment would earn less than the business’s cost of capital rate.

Other glossaries:

[Financial Accounting Glossary Part 1 – ACCOUNTING]
[Financial Accounting Glossary Part 3 – DIVIDEND PAYOUT RATIO]
[Financial Accounting Glossary Part 4 – INVENTORY TURNOVER RATIO]
[Financial Accounting Glossary Part 5 – PROFIT]