ICAB PL Financial Management key terms

The process of evaluating long-term investment projects, such as new plant or equipment, to decide which ones will create the most value for the business.

The sum of a project's future cash flows discounted to today at a required rate, minus its initial cost; a positive figure suggests the investment adds value.

The discount rate at which a project's future cash flows have a present value exactly equal to its initial cost, giving a zero net present value.

The length of time needed for cumulative cash inflows from a project to equal the original cash outlay, ignoring the time value of money.

A payback calculation in which each future cash inflow is first discounted to present value, so the recovery period reflects the time value of money.

The minimum return a company requires before it will accept a project; it is often set from the cost of capital plus a risk margin.

The interest rate used to convert future cash flows into today's value, reflecting the time value of money and the risk of the cash flows.

A future incremental cash flow that changes as a direct result of accepting a decision; past costs and allocated overheads are excluded.

Money already spent that cannot be recovered whatever decision is made, so it should be ignored when evaluating future alternatives.

The value of the best alternative forgone when a resource is used for one purpose, such as rental income lost when a owned building is used for a project.

The funds tied up in day-to-day operations, calculated as current assets such as inventory and receivables less current liabilities such as payables.

The number of days between paying suppliers for goods and receiving cash from customers, combining inventory days, receivable days and payable days.

The blended after-tax cost of a firm's debt and equity, weighted by their proportions in the capital structure, used as a discount rate.

The return shareholders require for holding a company's shares, reflecting the risk-free rate plus a premium for market and company risk.

A method of estimating the cost of equity as the risk-free rate plus beta multiplied by the market risk premium.

A measure of how much a share's return moves relative to the overall market; a beta above one indicates greater volatility than the market.

Market-wide risk that cannot be removed by diversification, such as changes in interest rates or economic recession, and is captured by beta.

Spreading investment across different assets so that company-specific risks offset each other, reducing total risk without lowering expected return.

The mix of debt and equity a company uses to finance its assets, which affects both financial risk and the overall cost of capital.

The proportion of a company's capital provided by debt rather than equity; high gearing increases financial risk and fixed interest obligations.

The added risk shareholders bear because a company uses fixed-interest debt, which magnifies swings in earnings available to ordinary shareholders.

The rules a company follows in deciding how much profit to distribute to shareholders and how much to retain for reinvestment.

A conflict of interest between managers and shareholders, for example when managers pursue growth or perks rather than maximising shareholder wealth.

The systems and controls by which a company is directed and held accountable, ensuring managers act in the interests of shareholders and other stakeholders.

Any party with an interest in a company's activities, such as shareholders, employees, lenders, customers or the wider community affected by its decisions.

The primary financial objective of increasing the long-term market value of ordinary shares, balancing dividends received with growth in share price.

The ability of a firm to meet short-term obligations as they fall due, usually assessed by comparing current assets with current liabilities.

Current assets divided by current liabilities, showing how many times short-term obligations could be covered by assets expected to turn into cash within a year.

Current assets excluding inventory, divided by current liabilities, giving a stricter test of short-term liquidity because inventory may be slow to sell.

Average trade receivables divided by credit sales, multiplied by 365, showing how long on average customers take to pay their invoices.

The rules a firm sets on who receives credit, how much, and for how long, balancing extra sales against the cost of financing receivables.

Testing how an investment appraisal result changes when one input, such as sales volume or cost, is varied while other assumptions stay fixed.

Evaluating a project under several coherent sets of assumptions, such as best case, worst case and most likely, to understand the range of outcomes.

The chance that actual returns differ from those expected, often measured by the variability or standard deviation of possible outcomes.

A financing decision comparing the cost of renting an asset over its life with purchasing it, usually analysed by discounting the relevant cash flows.

Profits kept in the business rather than paid out as dividends, forming an internal source of finance for growth and investment.

A collection of investments held together, whose combined risk depends on how the individual assets' returns move in relation to one another.