iLearn Glossary of TermsA | B | C | D | E | F | G | H, I | J, K, L | M | N | O | P | Q, R | S | T | U | V | W | X, Y, ZAAccrual Method - The most commonly used accounting method, which reports income when earned and expenses when incurred. Under the accrual method, companies do have some discretion as to when income and expenses are recognized, but there are rules governing the recognition. Accumulated Benefit Obligation - According to FAS87, "the actuarial present value of benefits (whether vested or unvested) attributed by the pension benefit formula to employee service rendered before a specific date and based on employee service and compensation before that date." Basically, this is the minimum pension liability that a firm has as of today, while assuming no continued employment or salary growth. Adjusted Book Value - the value that results after one or more asset or liability amounts are added, deleted, or changed from their respective financial statement amounts. Adjusted Earnings - Revenues minus cost of sales, operating expenses, and taxes, and special items - e.g. goodwill impairment, settlement expenses, employee stock option expense, etc. - over a given period of time, with the end result being the post-tax income from continued operations. Amortization - Writing off an intangible asset investment over the projected life of the assets. Arbitrage Pricing Model (APT) - An alternative to the Capital Asset Pricing Model, which specifies returns as a linear function of only systematic risk, the Arbitrage Pricing Model specifies returns as a linear function of more than a single factor resulting in multiple betas. Asset (Asset-Based) Approach - a general way of determining a value indication of a business, business ownership interest, or security by using one or more methods based on the value of the assets of that business net of liabilities.
BBalance Sheet - Often described as a "snapshot" of the company's financial condition on a given date. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time, instead of a period of time. It usually has three parts: assets, liabilities and shareholders' equity. The main categories of assets are usually listed first and are followed by the liabilities. The difference between the assets and the liabilities is known as the 'net assets' or the 'net worth' of the company. Beta - This key parameter in the Capital Asset Pricing Model measures the asset's non-diversifiable risk, also called systematic risk or market risk. Essentially, it measures the incremental risk added by a single stock when added to a fully diversified portfolio. Blockage Discount - an amount or percentage deducted from the current market price of a publicly traded security to reflect the decrease in the per share value of a block of those securities that is of a size that could not be sold in a reasonable period of time given normal trading volume. Book Value - Often used interchangeably with "net book value", which is the original acquisition cost (historical cost), less accumulated depreciation, depletion, or amortization. In terms of valuation, book value refers most often to balance sheet assets minus balance sheet liabilities. Business Enterprise - a commercial, industrial, service, or investment entity, or a combination thereof, pursuing an economic activity.
Business Valuation - the act or process of determining the value of a business enterprise or ownership interest therein.
CCapital Asset Pricing Model (CAPM) - Used in finance to determine a theoretically appropriate required rate of return (and thus the price if expected cash flows can be estimated) of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. The CAPM formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a number often referred to as Beta in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. Capital Structure - the composition of the invested capital of a business enterprise; the mix of debt and equity financing. Capitalization - a conversion of a single period stream of benefits into value. Capitalization Factor - any multiple or divisor used to convert anticipated benefits into value. Capitalization Rate - any divisor (usually expressed as a percentage) used to convert anticipated benefits into value. Cash Flow- cash that is generated over a period of time by an asset, group of assets, or business enterprise. Certainty Equivalence - This is a theoretical measure based on the expected utility of an executive's compensation portfolio - e.g. options, salary, bonuses, stock, etc. - which allows us to assign value to any single piece of that portfolio through the eyes of the individual. Control- the power to direct the management and policies of a business enterprise. Control Premium - an amount (expressed in either dollar or percentage form) by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a business enterprise, that reflects the power of control. Corporate Governance - The set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large. Credit Spread - The difference in yield between different securities due to different credit quality. Also known as "net credit spread". Cost Approach - a general way of estimating a value indication of an individual asset by quantifying the amount of money that would be required to replace the future service capability of that asset.
Cost of Capital - the expected rate of return (discount rate) that the market requires in order to attract funds to a particular investment.
DDepreciation - An accounting and finance term for the method of attributing the cost of an asset across the useful life of the asset. Depreciation is an example of applying the matching principle as per generally accepted accounting principles Discount for Lack of Control - an amount or percentage deducted from the pro rata share of value of an equity interest in a business to reflect the absence of some or all of the powers of control. Discount for Lack of Marketability- an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. Discount Rate - a rate of return (cost of capital) used to convert a monetary sum, payable or receivable in the future, into present value.
Discounted Cash Flow - Determines the present value of future cash flows by discounting them using the appropriate cost of capital.
EEarnings Quality - The amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. Economic Life - the period of time over which property may generate economic benefits. Equity Net Cash Flows - those cash flows available to pay out to equity holders (in the form of dividends) after funding operation of the business enterprise, making necessary capital investments, and reflecting increases or decreases in debt financing. Excess Earnings - that amount of anticipated benefits that exceeds a fair rate of return on the value of a selected asset base (often net tangible assets) used to generate those anticipated benefits.
Excess Earnings Method - a specific way of determining a value indication of a business, business ownership interest, or security determined as the sum of a) the value of the assets obtained by capitalizing excess earnings and b) the value of the selected asset base. Also frequently used to value intangible assets. See Excess Earning.
FFair Market Value - the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. {NOTE: In Canada, the term "price" should be replaced with the term "highest price"} Financial Accounting Standards Board - A seven-member independent board consisting of accounting professionals who establish and communicate standards of financial accounting and reporting in the United States. FASB standards, known as generally accepted accounting principles (GAAP), govern the preparation of corporate financial reports and are recognized as authoritative by the Securities and Exchange Commission. Forensic Accounting - the process of uncovering firms whose financials do not fully reflect the current and future state of their operations. Forced Liquidation Value - liquidation value at which the asset or assets are sold as quickly as possible, such as at an auction.
Fundamental Growth - The most internally consistent method of developing a firms expected growth rate, this method links a firms Reinvestment Rate and Return on Capital (ROC) to derive growth (g). g = Reinvestment Rate * ROC
GGoing Concern - an ongoing operating business enterprise. Going Concern Value- the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.
Goodwill - An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over book value usually accounts for the target firm's intangible assets.
H | IIncentive Stock Options (ISO) - A type of employee stock option with a tax benefit, when you exercise, of not having to pay ordinary income tax. Instead, the options are taxed at a capital gains rate when the underlying shares are sold. There are several restrictions on exercise and the sale of underlying shares that, if broken, can lead to shares being converted to non-qualified status, thus eliminating any tax advantage. Intangible Asset - An asset that is not physical in nature. Examples are things like copyrights, patents, intellectual property, and goodwill. These are the opposite of tangible assets. Invested Capital - the sum of equity and debt in a business enterprise. Debt is typically a) long-term liabilities or b) the sum of short-term interest-bearing debt and long-term liabilities. When the term is used, it should be supplemented by a definition of exactly what it means in the give valuation context. Invested Capital Net Cash Flows - those cash flows available to pay out to equity holders (in the form of dividends) and debt investors (in the form of principal and interest) after funding operation of the business enterprise and making necessary capital investments. Investment Risk - the degree of uncertainty as to the realization of expected returns.
Investment Value - the value to a particular investor based on individual investment requirements and expectations. {NOTE: In Canada, the term used is "Value to the Owner"}
J | K | LKey Person Discount - an amount or percentage deducted from the value of an ownership interest to reflect the reduction in value resulting from the actual or potential loss of a key person in a business enterprise. Lattice Model - The model divides time between now and the option's expiration into N discrete periods. At the specific time n, the model has an infinite number of outcomes at time n + 1 such that every possible change in the state of the world between n and n + 1 is captured in a branch. This process is iterated until every possible path between n = 0 and n = N is mapped. Probabilities are then estimated for every n to n + 1 path. The outcomes and probabilities flow backwards through the tree until a fair value of the option today is calculated. Wow, that is nice! Levered Beta - the beta reflecting a capital structure that includes debt. Liquidity- the ability to quickly convert property to cash or pay a liability.
Liquidation Value- the net amount that can be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either "orderly" or "forced".
MMonte Carlo - A problem solving technique used to approximate the probability of certain outcomes by running multiple trial runs, called simulations, using random variables. Majority Control - the degree of control provided by a majority position. Majority Interest - an ownership interest greater than fifty percent (50%) of the voting interest in a business enterprise. Market (Relative Value) Approach - a general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or other assets that have been sold. Market Value - The price if sold for cash. Marketability - the ability to quickly convert property to cash at minimal cost. Minority Discount - a discount for lack of control applicable to a minority interest. Minority Interest - an ownership interest less than fifty percent (50%) of the voting interest in a business enterprise.
Multiple - Another term for price/earnings ratio (P/E ratio or PE), which is a measure of the value of a company's stock determined by its current share price divided by its current annual earnings per share (EPS).
NNet Book Value - with respect to a business enterprise, the difference between total assets (net of accumulated depreciation, depletion, and amortization) and total liabilities of a business enterprise as they appear on the balance sheet (synonymous with Shareholder's Equity); with respect to an intangible asset, the capitalized cost of an intangible asset less accumulated amortization as it appears on the books of account of the business enterprise. Net Cash Flow - a form of cash flow. When the term is used, it should be supplemented by a qualifier (for example, "Equity" or "Invested Capital") and a definition of exactly what it means in the given valuation context. Net Tangible Asset Value- the value of the business enterprise's tangible assets (excluding excess assets and non-operating assets) minus the value of its liabilities. {NOTE: In Canada, tangible assets also include identifiable intangible assets} Non-Operating Assets- assets not necessary to ongoing operations of the business enterprise. {NOTE: In Canada, the term used is "Redundant Assets"}
Non-Qualified Deferred Compensation - Compensation that has been earned by an employee, but not yet received from the employer. Because the ownership of the compensation - which may be monetary or otherwise - has not been transferred to the employee, it is not yet part of the employee's earned income and is not counted as taxable income.
OOption Back-Dating - This is when firms, and their executives, assign grant dates to current options which correspond to previous stock price lows, or in advance of specific events, in order to increase the return on their employee stock options.
Orderly Liquidation Value - liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received.
PPremise of Value - an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; e.g. going concern, liquidation.
Projected Benefit Obligation - A more realistic approach to determining pension liability, this approach involves an additional assumption about salary growth in arriving at an estimate of future liability.
Q | RRate of Return- an amount of income (loss) and /or change in value realized or anticipated on an investment, expressed as a percentage of that investment. Replacement Cost New - the current cost of a similar new property having the nearest equivalent utility to the property being valued. Reproduction Cost New- the current cost of identical new property. Restricted Stock - Stock which is acquired though an employee stock option plan or other private means and which may not be transferred. Return on Capital (ROC) - A measure of how effectively a company uses the money (borrowed or owned) invested in its operations. If the Return on Invested Capital of a company exceeds its WACC, then the company created value. Reinvestment Rate - The amount of free cash flows left for internal investment by the firm after making payments to shareholders. This rate impacts the anticipated level of future growth under the Fundamental Growth Formula. Risk-Free Rate - the rate of return available in the market on an investment free of default risk. Risk Premium - a rate of return in addition to a risk-free rate to compensate the investor for accepting risk.
Rule of Thumb - a mathematical relationship between or among variables based on experience, observation, hearsay, or a combination of these, usually applicable to a specific
industry. This is not a valid method for arriving at a valuation conclusion.
SSensitivity Analysis - This iterative method involves determining the impact of each assumption used in a model upon the value of the asset/liability. Special Interest Purchasers - acquirers who believe they can enjoy post acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with their own. Standard of Value - the identification of the type of value being utilized in a specific engagement; e.g. fair market value, fair value, investment value. Sustaining Capital Reinvestment - the periodic capital outlay required to maintain operations at existing levels, net of the tax shield available from such outlays.
Systematic Risk - the risk that is common to all risky securities and cannot be eliminated through diversification. When using the capital asset pricing model, systematic risk is measured by beta.
TTax Shelter - Any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. Some examples include offshore companies and unique financing arrangements.
Terminal Value - In a discounted cash flow valuation, the cash flow is projected for each year into the future for a certain number of years, after which unique annual cash flows cannot be forecasted with reasonable accuracy. At that point, rather than attempting to forecast the varying cash flow for each individual year, one uses a single value representing the discounted value of all subsequent cash flows.
UUnderwater Option - Stock options in which the strike price (the price at which the employee is contracted to buy the shares) is higher than the current stock price. Unlevered Beta - the beta reflecting a capital structure without debt.
Unsystematic Risk - the portion of total risk specific to an individual.
VValuation - the act or process of determining the value of a business, business ownership interest, security or other asset.
Volatility - A statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security.
W
Weighted Average Cost of Capital (WACC) - An average representing the expected return on all of a company's securities. Each source of capital, such as stocks, bonds, and other debt, is assigned a required rate of return, and then these required rates of return are weighted in proportion to the share each source of capital contributes to the company's capital structure. The resulting rate is what the firm would use as a minimum for evaluating a capital project or investment.
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