Terminologies


Amortization
A non cash expense item in the income statement for intangible assets. It is similar to depreciation which is used for tangible assets. It’s purpose is to match the capital asset’s expenses with the revenue it generates. Used in accrual accounting to match revenues.

Depreciation
Depreciation is the expense item in the income statement for tangible assets. It’s purpose is to match the tangible asset’s expenses with the revenue that it generated that year. Used in accrual accounting but does not show up in cash accounting.

Discount Rate
This is the interest rate used in the discounted cash flow models to find the present value of all future cash flows of an entity. The discount rate includes adjustments for time value of money and risk. Check Investopedia for a complete guide to calculating the discount rate.

Discounted Cash Flow (DCF)
Discounted cash flow is the model that is used to determine today’s value of all future cash flow of an entity. This model accounts for time value of money, risk, and perpetuity of cash flows.

EBITDA (Earning Before Interest Taxes Depreciation Amortization)
EBITDA is the earnings of an entity before deducting for interest, taxes, depreciation and amortization. The purpose of using this earnings is to determine the cash flow to firm while leaving out cost factors like financing(interest), taxes (entity type & different tax structures), and non-cash expenses (depreciation and amortization).

Financial ratios
Financial ratios are mathematical ratios of two items in a financial statement used as a benchmark comparison among different companies. It allows for the comparison using the same base point. A full list of financial ratios can be found here on investopedia.

Marketability
The marketability of a company is the ease at which the shares in part or as a whole company can be sold. A publicily listed company has the highest marketability because of the stock exchange and open market. A small, privately held business has the lowest marketability because it is not as easy and efficient to sell.

Multiples
The multiples of “something” refers to the multiplication of a base number. For example,3 times multiples of earnings is equal to 300 if the earnings is 100. It is a simplistic approach to finding value. Most people do not realize that the multiples used in finance is not an arbitrary number but that the multiple is actually derived using one or more valuation methodologies. The multiple is a derivative of those methods.

Net Present Value (NPV)
The total of all the present values of earnings at different future times. i.e. PV of year 1 + PV of year 2 + PV of year 3 = NPV. Here is a a summarized calculation of NPV in the DCF model.

Nominal
A number that is unadjusted for inflation or other factors. In essence a raw, direct number. The other number is “Real” which is adjusted for inflation.

Normalize
Normalize is the adjustment for earnings or balance sheet to add back small medium business owner benefits, non-recurring expenses, undo tax optimization strategies. It is used to find the true earnings potential of an SME.

PE Ratio
The Price Earnings Ratio is used often in the financial markets to determine if the price of a stock/company is under or over valued in comparison to other companies or time periods. Is is derived by dividing the price to earnings. In the case of public companies, the earnings would be to equity or net income.

Present Value (PV)
Present value is the value of tomorrow’s dollar in today’s value. A dollar 5 years from now is worth less than a dollar given today because of inflation and opportunity cost (you could invest it today and have it worth more in 5 years). The use of PV is to extract a single value adjusted for today of all future cash flows.

Real
Real is the number that is adjusted for inflation. For example real rate or real earnings are adjusted for inflation.

SEC
The Securities Exchange Commission is the oversight committee for the U.S. stock markets.

Seller Discretionary Cash Flow (SDCF)
Seller Discretionary Cash Flows have been normalized to reflect the true earnings potential of the business to which owner benefits and all other optimization strategies have been adjusted out.

Seller Discretionary Earnings (SDE)
Seller Discretionary Earnings is another name for SDCF.

SME
Small and Medium Enterprises.

Terminal Value (Residual Value)
The Terminal Value is used in DCF model to calculate the perpetuity of earnings forever after a certain point. For example, if earnings are projected to year 5 and discounted to find the PV for today. Terminal Value represents the value of the cash flows from year 6 to infinity. An often used model to calculate Terminal Value is the Gordon Growth Model.

Time Value of Money
Time value of money is the change in the value of money over time due to interest rates and opportunity costs. So any amount of money is worth more today than it is at any point in the future. A dollar today is worth more than a dollar in 5 years because the dollar today can be banked in and earn interest for 5 years.

Weighted Average Cost of Capital (WACC)
All firms require capital to start, operate and grow. Since all capital is typically externally funded, we need to find the cost of these “loans” to the company. Weighted Average Cost of Capital is the calculation of a company’ cost of capital. The equation includes cost of equity and cost of debt.