Finance and Lending
The Business Owner’s Guide to Financial Terminology
September 10, 2020 |
The C2FO Team
Do you know your DSO from your DPO? How about your company’s COGS and NPS? If these terms leave you scratching your head, this quick, handy guide can help.
If you’re like most entrepreneurs, you probably didn’t start your own business because of a deep, abiding love for balance sheets and income statements.
Still, a familiarity with some basic finance and accounting terminology is essential for any small to mid-sized business owner. Below are some of the more common terms we come across at C2FO, accompanied by some simple, easy-to-understand definitions.
Money that is owed to your company from a customer or a debtor. For example, if you sell a product or provide a service, you record an account receivable for unpaid invoices that are due from that customer.
Money that your company must pay a supplier or a trading partner. An account payable is usually recorded on your balance sheet under short-term liabilities.
Cash Conversion Cycle
The Cash Conversion Cycle (CCC) is a key metric used to evaluate the efficiency of a company’s operations and management. The CCC measures how long it takes to convert investments in inventory and other resources into cash flows from sales.
CCC accounts for:
- How much time your company needs to sell its inventory
- How much time it takes to collect receivables
- How much time you have to pay your bills without incurring penalties
The above stages make up the CCC, expressed as the mathematical formula below:
CCC = Days of Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) − Days Payables Outstanding (DPO)
Bottom line: the quicker your business can collect payments on invoices, the shorter your CCC becomes.
The acronym stands for “cost of goods sold,” the value of goods that are sold during a particular period of time. COGS can include purchasing, conversion and other expenses related to selling inventory and moving it to a new location.
Stands for “days inventory outstanding.” This is a metric that companies use to measure the average number of days they hold on to inventory before selling it.
This means “days payable outstanding.” This metric is used by companies to indicate the average number of days it takes to pay suppliers for goods or services. The earlier you pay your supplier invoices, the shorter your average DPO.
Days sales outstanding, or DSO, measures the average number of days it takes a supplier to be paid for goods or services provided.
An acronym for “earnings before interest, taxes, depreciation and amortization.” EBITDA is a metric used by many companies to measure operating profitability before interest expenses, taxation, depreciation and amortization are subtracted.
Often included on an income statement, EBITDA provides insight into a company’s cash flow and the profit generated from existing sales and assets.
Short for “generally accepted accounting principles.” This is a common set of accounting rules and principles that all publicly traded companies in the United States must follow when compiling and reporting their financial statements.
Short for “London Interbank Offered Rate.” This is the basic rate of interest used in lending among banks in London’s interbank market and is also used as a point of reference for setting interest rates on other loans.
A common term that explains the number of days before the net amount payment on a good or service is due. For some industries, “net 30” is the standard invoice payment term between suppliers and buyers. For other industries, the term may be as short as net 10 or net 15, or longer than net 60.
A net promoter score, or “NPS,” is a management tool that can be used to gauge the loyalty of a firm’s customer relationships. It serves as an alternative to traditional customer satisfaction research and is claimed to be correlated with revenue growth. More than two-thirds of Fortune 1000 companies use NPS as a metric.
An NPS score can be as low as -100 or as high as +100. A score in the positive range is generally considered to be good.
Also called the “prime lending rate” or just “prime,” this refers to an interest rate used by banks, usually the rate at which they lend to favored customers (i.e., those with good credit). Some variable interest rates may be expressed as a percentage point above or below the prime rate.
Short for “annualized percentage rate.” This calculates an interest rate for an entire year, as opposed to a monthly fee or rate.
In calculating an APR for early payment, C2FO uses the following formula: APR = discount x (360/days paid early).
Here’s an example of how the formula works: Let’s say a supplier offers a 1% discount on invoices and gets paid early by 40 days. The calculation for APR would be 1% x (360/40) = 9%.
A claim or legal right against an asset or property to ensure the payment of a debt or another obligation. The owner of the property who grants the lien is called a “lienee,” and the person who benefits from the lien is a “lienor” or a lien holder.
MSA (Master Service Agreement)
A contract between a buyer and supplier that outlines the standing terms of the relationship. Typical terms found in an MSA include payment terms, product warranties, intellectual property ownership, dispute resolution, geographic location, and venue of law. An MSA saves time and resources by negating the need for parties to repetitively negotiate terms for each purchase order.
The capital of a business that is used in its day-to-day trading operations, calculated as current assets minus the current liabilities.
A blanket term used to describe financial channels, processes and products that fall outside the traditional financial system that includes banks and capital markets. Some examples of alternative financing can include asset-based lending, merchant cash advances, supply chain finance, crowdfunding, invoice factoring and early payment.
ABL (Asset-Based Lending)
A lending product that is secured by a company’s assets as opposed to unsecured lending. In short, if the loan is not repaid, the asset may be taken. A mortgage is an example of asset-based lending.
Business Line of Credit
Credit that is extended to a business client. Also known as an “LOC,” a business line of credit offers “revolving” credit, meaning that borrowers can draw funds at any time up to a predetermined limit and pay it off whenever they can. As with credit cards, paying off the balance replenishes the maximum accessible funds.
A form of financing in which a business sells its accounts receivable at a discount to a third-party financer (often called a “factor”) in exchange for a lump sum of cash, usually between 70% to 90% of the invoice value. The factoring company now owns the invoices and gets paid when it collects from the company’s customers, typically in 30 to 90 days.
Short-Term Business Loan
Refers to a lump sum provided to a company to cover unexpected expenses and meet other financing needs. Borrowers can pay off the loan in monthly, weekly, or daily installments over three to 36 months, with interest rates starting around 8%. Loan amounts can range from $2,500 to $500,000.
Supply Chain Finance (SCF)
Supply chain finance, which is also known as supplier finance or reverse factoring, enables companies to pay their suppliers faster to improve their liquidity. The current form of SCF has been around for more than 40 years. It’s an effective way for suppliers to receive early payment for a fixed rate. Most SCF programs are set up by large companies in collaboration with a bank.
Also nicknamed CapFin, this is the C2FO organization that offers working capital options to customers outside of our Early Payment solution. Capital Finance’s product offerings include Receivables Finance, an asset-based lending program that works in tandem with Early Payment.
Short for “days paid early,” this is a term coined by C2FO to explain the difference in number of days between an invoice’s original due date and the date when early payment was received.
Dynamic Supplier Finance (DSF)
Dynamic Supplier Finance (DSF) is a flexible funding option from C2FO that allows companies to seamlessly toggle early payment to their suppliers between their balance sheets and other funding sources. DSF enables suppliers of all sizes to easily accelerate invoices from their customers — on-demand and at their choosing.
Early payment is a form of financing in which a supplier and a customer agree to early payment on a supplier’s invoice in exchange for a discount on the invoice amount for the customer. In short, an early payment discount is an incentive for a customer to pay you earlier than your agreed-upon terms, allowing you to increase your cash flow sooner than you would while waiting for payment.
This is a discount the supplier has agreed to pay the buyer upon receipt of early payment. Typically established in the contract governing the relationship. “2% 10 Net 30” or “Two Ten Net Thirty” is a common static discount term meaning, if the buyer pays the supplier within 10 days of the invoice date, that buyer can take a 2% discount on the invoices paid. If the buyer misses the 10 day window, the buyer will pay the supplier in 30 days and take no additional discount.
Working capital, working for you
Working capital (defined above as “current assets minus current liabilities”) is crucial to operating any business. As the world’s largest non-bank provider of working capital, C2FO is committed to helping companies like yours gain access to the capital needed to grow.
To learn more about how working capital solutions like early payment can help your business, visit https://legacy-site.c2fo.com/vendors/.
Sources: Investopedia, Forbes, Accounting.com, Klemchuk LLP, Bankrate.com, Corporatefinanceinstitute.com