Glossary
This glossary is your reference companion throughout this book. When a financial term feels unclear or you need a quick reminder of what something means in context, return here to refresh. Each entry pairs a definition with a practical example so you can anchor the concept to real-world financial reporting.
Accounting equation
Assets = Liabilities + Shareholders' Equity. This fundamental balance sheet identity ensures that every transaction is recorded in a way that keeps both sides equal. If a company borrows $1 million in cash, assets (cash) increase by $1 million and liabilities (debt) also increase by $1 million, keeping the equation in balance.
See also: Balance sheet, Shareholders' equity.
Accrual accounting
Revenue and expenses are recognized when earned or incurred, regardless of when cash changes hands. Under accrual accounting, a software company records revenue when it delivers a contract, even if the customer pays 30 days later. Similarly, it records an expense when it receives an invoice, not when it pays the bill.
See also: Revenue recognition, Deferred revenue.
Accumulated depreciation
The cumulative depreciation expense charged against an asset since its acquisition. When a company buys a $100,000 piece of machinery and depreciates it over 10 years, after 3 years accumulated depreciation will be roughly $30,000. On the balance sheet, accumulated depreciation is subtracted from the asset's original cost to show net book value.
See also: Depreciation, PP&E.
Allowance for doubtful accounts
An estimate of customer receivables that will never be paid. When a retailer extends credit and some customers default, it estimates the uncollectible portion and sets aside an allowance. If receivables total $10 million and the company estimates 2% will be uncollectible, it records an $200,000 allowance, reducing net receivables on the balance sheet.
See also: Accounts receivable, Revenue recognition.
Amortization
The systematic write-down of the cost of an intangible asset over its useful life. Similar to depreciation for tangible assets, amortization applies to patents, trademarks, software, and other non-physical assets. A company that acquires a patent for $5 million with a 20-year life will amortize $250,000 per year, reducing both the asset value and net income.
See also: Intangible asset, Goodwill.
Audit opinion
The auditor's formal conclusion about whether financial statements fairly present the company's financial position and results. An unqualified opinion (clean) means the statements are presented fairly in all material respects. A qualified opinion includes caveats about specific items, while an adverse opinion means the statements are misleading.
Balance sheet
A financial statement showing assets, liabilities, and shareholders' equity at a specific point in time. Also called a statement of financial position, the balance sheet is a snapshot—typically taken on the last day of a quarter or year. It answers the question: what does the company own, what does it owe, and what equity do owners have?
See also: Accounting equation, Income statement.
Bookings
Signed customer contracts or purchase orders that represent future revenue, recognized under revenue recognition rules. For a SaaS company, a multi-year subscription agreement signed in Q1 may be "booked" revenue even though cash and recognized revenue are spread across future quarters. Bookings are a leading indicator of future revenue.
See also: Revenue recognition, Deferred revenue.
Capex
Capital expenditure; money spent on acquiring, upgrading, and maintaining physical assets. A retailer opening a new store incurs capex for real estate, fixtures, and equipment. Capex is not expensed immediately but capitalized on the balance sheet and then depreciated, which is why it impacts cash flow immediately but income statement impact spreads over years.
See also: PP&E, Depreciation.
Capitalization
The process of recording an expenditure as an asset rather than immediately as an expense. When a company builds software for internal use, it capitalizes the development cost on the balance sheet instead of expensing it. Over time, the capitalized amount is amortized, matching the cost to the periods when the asset generates benefit.
See also: Capex, Amortization.
Cash flow statement
A financial statement showing how cash moved in and out of the business during a period, divided into operating, investing, and financing activities. The cash flow statement explains why net income (an accounting profit) differs from actual cash earned. A company can be profitable on its income statement but still have negative operating cash flow if customers are slow to pay or inventory is building.
See also: Operating cash flow, Free cash flow.
Channel stuffing
A manipulative practice in which a company sells large quantities of product to distributors or retailers regardless of actual demand, artificially inflating revenue. In the 1990s, some technology vendors shipped excess inventory to channel partners, recognizing full revenue upfront. When demand didn't materialize, distributors returned the product, and revenue had to be reversed—a warning sign of unsustainable growth.
See also: Revenue recognition.
Common stock
Shares of ownership in a company that carry voting rights and a residual claim on earnings and assets after all liabilities and preferred obligations are settled. Common stock is the most junior form of equity; common shareholders have voting power but receive dividends only after preferred shareholders. When a startup exits through acquisition or IPO, common shareholders benefit from the upside after creditors and preferred shareholders are paid.
See also: Diluted EPS, Shareholders' equity.
Comprehensive income
The total change in shareholders' equity from all sources other than owner transactions, including net income plus other comprehensive income items. Other comprehensive income includes unrealized gains and losses on investments, foreign currency translation adjustments, and certain pension remeasurements. A company can report net income of $100 million but comprehensive income of $90 million if foreign subsidiaries experienced currency losses.
See also: Net income.
Contingent liability
A potential obligation that may arise depending on the outcome of a future event. A company facing a lawsuit discloses the contingent liability in footnotes; if the lawsuit is probable and can be estimated, the liability is accrued on the balance sheet. Pending environmental remediation, warranty claims, and regulatory fines are examples of contingencies.
See also: Accrual accounting, Notes to financial statements.
Cost of goods sold
Direct costs to produce goods that a company sells, including raw materials and direct labor but excluding overhead. If a manufacturer produces 10,000 units at a material and labor cost of $50 per unit, COGS is $500,000 regardless of how many units are sold. COGS is subtracted from revenue to calculate gross profit.
See also: Gross margin, Operating expenses.
Deferred revenue
Cash received from customers in advance of delivering goods or services, recorded as a liability until revenue is earned. When a software company sells a one-year subscription for $12,000 upfront, it records $12,000 as deferred revenue (a liability). Each month, $1,000 is recognized as revenue, reducing the liability and increasing net income.
See also: Revenue recognition, Accrual accounting.
Deferred tax
Tax expected to be paid or recovered in future periods due to differences between financial and tax accounting. A company might depreciate an asset faster for tax purposes than for financial reporting. This creates a deferred tax liability if taxes will be higher in future years, or a deferred tax asset if taxes will be lower.
See also: GAAP.
Depreciation
The systematic allocation of an asset's cost over its useful life, reflecting wear, obsolescence, or use. A company buying a delivery truck for $50,000 with a 5-year useful life might depreciate it $10,000 per year. Depreciation is a non-cash expense—no cash leaves the company—but it reduces both the asset's book value and reported net income.
See also: Accumulated depreciation, PP&E.
Diluted EPS
Earnings per share calculated as if all potentially dilutive securities (stock options, convertible bonds, restricted stock) were converted to common stock. If a company has 100 million shares outstanding but 10 million shares of additional dilution from in-the-money options, diluted EPS uses 110 million shares in the denominator. Diluted EPS is always lower than basic EPS and is the more conservative metric.
See also: EPS, Stock-based compensation.
EBIT
Earnings before interest and taxes; operating profit calculated as revenue minus operating expenses. EBIT excludes the effects of capital structure (interest expense) and tax policy, making it useful for comparing profitability across companies with different leverage or tax rates. A company with revenue of $500 million, COGS of $300 million, and operating expenses of $150 million has EBIT of $50 million.
See also: EBITDA, Operating expenses.
EBITDA
Earnings before interest, taxes, depreciation, and amortization; a measure of cash-generating ability that strips out non-cash charges. EBITDA is popular in leveraged buyouts and valuation because it approximates cash available to pay creditors. However, it can be misleading if a company is heavily reinvesting in assets; a company with high EBITDA but heavy capex requirements may have low free cash flow.
See also: EBIT, Free cash flow.
EPS
Earnings per share; net income divided by the weighted-average number of shares outstanding during the period. If a company earns $50 million in net income and has 20 million shares outstanding, EPS is $2.50. EPS is a key metric investors track because it directly reflects earnings power attributable to each share.
See also: Diluted EPS, Net income.
Fair value hierarchy
A three-level framework for measuring assets and liabilities at fair value, based on the quality of inputs available. Level 1 uses quoted prices in active markets (most reliable); Level 2 uses observable market inputs like interest rates; Level 3 uses unobservable inputs requiring significant judgment. A company may fair-value a complex derivative using Level 3 inputs, signaling higher measurement uncertainty.
FIFO
First-in, first-out; an inventory valuation method assuming the oldest inventory is sold first. Under FIFO, in a period of rising prices, the cost of goods sold reflects older (cheaper) inventory costs, resulting in higher gross profit and higher net income compared to LIFO. FIFO is often used by retailers because it matches the physical flow of goods.
Free cash flow
Operating cash flow minus capital expenditures; cash available for investors after maintaining or expanding the asset base. Free cash flow is what remains after a company invests in PP&E to sustain and grow the business. A company with operating cash flow of $100 million and capex of $30 million has free cash flow of $70 million available for debt repayment, dividends, or acquisitions.
See also: Operating cash flow, Capex.
GAAP
Generally Accepted Accounting Principles; the standard framework for financial reporting in the United States, established by the Financial Accounting Standards Board. GAAP includes detailed rules for revenue recognition, asset valuation, and disclosure. Companies filing with the SEC must follow GAAP unless reporting under IFRS for non-US filers.
Going concern
An assumption in financial reporting that an entity will continue operating indefinitely rather than being liquidated. Auditors assess going concern when doubt exists about a company's ability to meet obligations. If a company is burning cash at an unsustainable rate or faces imminent litigation, auditors may qualify the audit opinion with a going concern warning.
See also: Audit opinion.
Goodwill
The premium paid for an acquisition above the fair value of identifiable net assets, representing expected synergies or brand value. When Company A acquires Company B for $100 million and the identifiable net assets are worth $60 million, the $40 million difference is goodwill. Goodwill is tested for impairment annually; if the acquisition underperforms, goodwill may be written down.
See also: Impairment, Intangible asset.
Gross margin
Gross profit divided by revenue, expressed as a percentage; measures the efficiency of production before operating expenses. If a company has revenue of $1 million and COGS of $400,000, gross profit is $600,000 and gross margin is 60%. Gross margin signals pricing power and production efficiency; higher margins suggest competitive advantage or premium products.
See also: Cost of goods sold, Operating margin.
IFRS
International Financial Reporting Standards; the accounting framework used in over 140 countries outside the United States, issued by the International Accounting Standards Board. IFRS emphasizes principles-based accounting and includes different rules than GAAP for revenue recognition, lease accounting, and asset impairment. A multinational company may prepare consolidated financials under IFRS but subsidiary reports under local GAAP.
See also: GAAP.
Impairment
A reduction in the book value of an asset when its fair value falls below its carrying value, indicating the asset has lost value. If a company owns a building that was capitalized at $50 million but market conditions cause its fair value to drop to $35 million, an impairment charge of $15 million is recorded. Impairment charges are non-cash but reduce net income and total assets.
See also: Goodwill, Accumulated depreciation.
Income statement
A financial statement showing revenue, expenses, and net income over a period, summarizing financial performance. Also called the profit and loss statement or P&L, the income statement answers: did the company make money this quarter or year? It flows from revenue at the top through increasingly refined profitability measures (gross profit, operating income, net income) toward the bottom.
See also: Balance sheet, Net income.
Intangible asset
A non-physical asset with value, such as patents, trademarks, customer relationships, or software. Unlike PP&E, intangible assets are harder to value and have uncertain useful lives. When a company acquires another, much of the purchase price is often allocated to intangible assets and goodwill.
See also: Amortization, Goodwill.
Inventory
Goods held for sale or raw materials and work-in-process used in production. Inventory is a current asset on the balance sheet, valued at the lower of cost or net realizable value. For a retail chain, inventory includes finished goods on shelves; for a manufacturer, it includes raw materials, work-in-process, and finished goods at various production stages.
See also: FIFO, LIFO, Cost of goods sold.
LIFO
Last-in, first-out; an inventory valuation method assuming the newest inventory is sold first. Under LIFO, in a period of rising prices, COGS reflects newer (more expensive) inventory, resulting in lower gross profit and lower net income compared to FIFO. LIFO is less common today but was popular for tax benefits; it is not permitted under IFRS.
MD&A
Management's Discussion and Analysis; the section of SEC filings where management explains financial results, trends, risks, and strategy. The MD&A is often the most candid part of a 10-K, where management discusses why revenue grew, what risks threaten the business, and how they plan to compete. Experienced investors read MD&A carefully to understand management's perspective and identify red flags.
See also: 10-K.
Net income
Bottom-line profit; revenue minus all expenses, interest, and taxes, representing what accrues to shareholders. Net income is the most commonly cited profitability metric and is used to calculate EPS. A company might have strong revenue but low net income if operating expenses or interest costs are high.
See also: Income statement, EPS.
Non-GAAP
Financial measures calculated outside the GAAP framework, used by companies to highlight alternative views of performance. Examples include adjusted EBITDA (EBITDA excluding one-time items), free cash flow, and operating cash flow. Companies use non-GAAP measures to show what they believe is "normal" performance, but these measures can be gamed; investors should demand clear reconciliations to GAAP.
See also: GAAP.
Non-controlling interest
The portion of a subsidiary's equity that is not owned by the parent company, shown as a liability or equity on the consolidated balance sheet. When a parent owns 80% of a subsidiary, the other 20% is non-controlling interest. On the consolidated income statement, non-controlling interest is deducted to arrive at net income attributable to the parent.
See also: Shareholders' equity.
Notes payable
Short-term or long-term debt obligations to creditors, recorded as liabilities on the balance sheet. A company might issue a note payable to a bank or supplier specifying an interest rate and repayment schedule. Notes payable are distinguished from accounts payable (informal short-term obligations to suppliers).
See also: Accounts payable.
Operating cash flow
Cash generated by a company's core business operations, before investing or financing activities. Operating cash flow is the most reliable measure of profitability because it reflects actual cash, not accounting judgments. A company with declining operating cash flow despite stable net income is a red flag, suggesting earnings quality issues.
See also: Cash flow statement, Free cash flow.
Owner earnings
A measure of cash available to owners after maintenance capex, calculated roughly as net income plus depreciation minus maintenance capex. Warren Buffett popularized owner earnings as a way to estimate true cash-generating ability without being distracted by non-cash charges or growth capex. Unlike EPS or GAAP earnings, owner earnings approximates what an owner could pocket annually.
See also: Free cash flow, Net income.
PP&E
Property, plant, and equipment; tangible long-lived assets used in operations, including land, buildings, machinery, and vehicles. PP&E is shown on the balance sheet gross (at original cost) with accumulated depreciation subtracted to show net book value. Capital-intensive industries like manufacturing and utilities have large PP&E; service companies may have minimal PP&E.
See also: Depreciation, Capex.
Retained earnings
The cumulative net income (or loss) retained in the business since inception, minus any dividends paid to shareholders. Retained earnings grow each quarter by the amount of net income and shrink by the amount of dividends paid. Over time, retained earnings are typically the largest component of shareholders' equity.
See also: Shareholders' equity, Net income.
Revenue recognition
The accounting principle determining when revenue is recorded, typically when a company satisfies a performance obligation to a customer. Under the current standard (ASC 606), revenue is recognized when control of goods or services transfers to the customer. A SaaS company recognizes revenue as it provides services each month, not upfront when cash is received.
See also: Accrual accounting, Deferred revenue.
SOX
The Sarbanes-Oxley Act of 2002; U.S. federal law requiring public companies to maintain accurate financial records and have auditors attest to internal control effectiveness. SOX was enacted after the Enron and WorldCom scandals to improve financial transparency and accountability. Section 404 of SOX requires management and auditors to assess internal controls over financial reporting.
See also: Audit opinion.
Stock-based compensation
Employee compensation paid in company stock, stock options, or restricted stock units rather than cash. Stock-based compensation is expensed on the income statement (reducing net income) and recorded as a liability or equity on the balance sheet. High stock-based compensation can be dilutive to existing shareholders if options are exercised or RSUs vest.
See also: Diluted EPS.
Treasury stock
Shares repurchased and held by the company, reducing the number of shares outstanding. When a company buys back its own stock (often as a capital allocation tool or to offset dilution from employee options), it records treasury stock as a contra-equity account. Treasury stock reduces both assets and shareholders' equity on the balance sheet.
See also: Common stock, Shareholders' equity.
Working capital
Current assets minus current liabilities, measuring short-term financial health and operational liquidity. A company with $500 million in current assets and $300 million in current liabilities has working capital of $200 million. Growing businesses often require increases in working capital to finance inventory and receivables, which ties up cash.
See also: Balance sheet, Cash flow statement.