Amount owed to a creditor, usually a supplier, arising from purchase of materials, supplies, or services, not necessarily due or past due

Amount owed by a debtor, usually a customer, arising from sales or services provided, not necessarily due or past due

see Profitability index

Factor that measures how risky an individual investment is relative to the market

A beta of 1 means that an investment has exactly the same risk as the market. You can find more information about beta in FinanceIsland's Risk & CAPM tutorial.

Financial model that defines the relationship between risk and return

The premise of the model is that the expected investment return varies in direct proportion to its risk, i.e., the riskier the investment – whether in the stock market, in research & development, or in capital investments – the higher return you should expect. You can find more information about the application of CAPM in business decisions in FinanceIsland's Risk & CAPM tutorial.

Purchases of long-lived assets, usually high-ticket items, that are capitalized instead of being expensed

According to accounting and tax regulations, long-lived business assets have to be capitalized and depreciated over time instead of being expensed. For example, a new $1M machinery equipment may be capitalized and depreciated over 10 years, resulting in a $100k annual depreciation over those 10 years, assuming that the straight-line depreciation method is used.

Cash receipts from customers, investors, or other sources (cash inflows), and cash disbursements to suppliers, employees, investors, or other sources (cash outflows)

Range between confidence limits, which reflects how confident you can be that a metric calculated based on your data set will lie within these limits (see also FinanceIsland's basic statistics tutorial)

Analysis-specific measure of the profit contribution

Unlike standard financial metrics such as gross margin (= net revenues - cost of sales) and operating profit (= gross margin - operating expenses), contribution margin is a somewhat vague metric whose definition varies from analysis to analysis. Hence, it's important to understand the definition of contribution margin used by the analyst before making any meaningful decisions. The benefit of contribution margin is, however, that it can focus on the relevant variable drivers impacting the analysis results. For example, in a optimal supply analysis the contribution margin may be defined as gross margin minus disposal cost. Since only gross margin and disposal cost are the variable components of the supply options, it is sufficient to analyze only this contribution margin without the need for analyzing operating profit.

Number of days between the time a purchase is booked in the accounting systems and the time the supplier is paid for that purchase

Although DPO may vary from purchase to purchase and from supplier to supplier, an average company DPO is often used in financial models. Financial models, including FinanceIsland's tools, assume also that the supplier bills the company at the beginning of the time period. Usually, DPO varies between 30 and 90 days but for some industries and companies it may be outside of this range.

Number of days between the time a sale is recorded in the accounting systems and the time the company receives cash for that sale

Although DSO may vary from customer to customer, an average company DSO is often used in financial models. Financial models, including FinanceIsland's tools, assume also that the customer is billed at the beginning of the time period. Usually, DSO varies between 30 and 90 days but for some industries and companies it may be outside of this range.

Allocation of the cost of an asset over its useful life

For accounting and tax purposes, long-lived business assets need to be capitalized or amortized instead of being expensed. Depreciation is amortization of plant assets such as equipment, machinery, or physical structures. Depreciation allocates the cost of a capital investment over its depreciation period. There are several depreciation methods including straight-line depreciation and accelerated depreciation. In the case of the straight-line depreciation for example, a $1M machinery equipment can be depreciated over its 10-year life resulting in an annual depreciation of $100k over those 10 years.

Time frame, usually number of years, during which capital investments are depreciated

Rate of return to calculate the present value of future cash flows

The discount rate, also referred to as rate of return, hurdle rate, or opportunity cost of capital, is a proxy for the financial risk associated with any investment. This opportunity cost is the return forgone by investing in a specific project rather than in comparable investment alternatives. The discount rate is determined based on the first basic principle of finance that a dollar today is worth more than a dollar tomorrow and based on the second basic finance principle that a safe dollar is worth more than a risky dollar. Since the discount rate needs to be determined based on the risk of the investment, a financial model such as the Capital Asset Pricing Model (CAPM) can be used for that purpose. You can find more information about choosing an appropriate discount rate for various investment projects in FinanceIsland's Risk & CAPM tutorial.

Present values of future cash flows, whether in- or outflows

Expanded version of the payback period

The payback period represents the number of periods it takes until the cumulative cash flow becomes positive. Since this rule doesn't take the time value of money into account, a slightly better version of this metric is the discounted payback period, which is based on cumulative discounted cash flows. Investment projects are accepted if the payback period meets some predefined cutoff period. Since this cutoff period is chosen arbitrarily, the payback period is a subjective measure. It simply ignores any cash flows after the cutoff. You can find more information about the payback period and other financial metrics in this post on FinanceIsland's blog.

Expanded version of the profitability index (PI)

The profitability index (also referred to as the benefit-cost ratio) is the present value of future cash flows divided by the initial investment. DPI is an expanded version of the profitability index and discounts also the initial investment, which may not always be incurred in the first period of the project. Usually, an investment project should be accepted if DPI is greater than 1.

Cost associated with disposing products that were produced or ordered but cannot be sold to customers or returned to suppliers

Company's tax rate based on the federal tax rate and potentially adjusted for state or local taxes

Interest rate charged by a financial institution for a lease or loan

Discount rate at which NPV is zero

Although IRR is widely used in finance, it has several drawbacks. These drawbacks include potentially multiple IRRs and the inability to rank projects with different patterns of cash flow. In an ideal case though, you should accept any investment project offering an IRR above the opportunity cost of capital. You can find more information about IRR and other financial metrics in this post on FinanceIsland's blog.

Raw materials, supplies, work in process, and finished goods

Number of times the average inventory is sold during a year

Although inventory turns may vary from product to product, usually company's average inventory turns are used in financial models. Financial models, including FinanceIsland's tools, assume also that goods become part of inventory at the beginning of the time period before being shipped to customers. Inventory turns are calculated as the annual cost of sales divided by the average inventory for the same year.

Contribution margin that cannot be achieved due to limited supply (see also Contribution margin)

Revenues that cannot be achieved due to limited supply (also referred to as opportunity costs)

Component of the Capital Asset Pricing Model (CAPM) that describes how much more risky the market as a whole is in comparison with a risk-free investment (see also FinanceIsland's Risk & CAPM tutorial)

Sum of all data points divided by the number of data points, also known as average (see also FinanceIsland's basic statistics tutorial)

Most common value in a data set (see also FinanceIsland's basic statistics tutorial)

Another representation of the interest rate in a lease

The money factor may be used by leasing companies to simplify the calculation of the monthly lease financing fee. The money factor equals annual interest rate times 100 divided by 2400. For more details, please see definition of the monthly lease financing fee.

Sophisticated scenario analysis

Monte Carlo simulation allows to investigate thousands of scenarios in a short period of time. These scenarios are defined through a probability distribution and its simulation parameters. You can find more information about Monte Carlo simulation in FinanceIsland's Monte Carlo simulation tutorial.

Part of the monthly lease payment that covers the depreciation of the equipment

The monthly lease payment consists of two components: depreciation fee and lease financing fee. The depreciation fee covers the loss of value of the equipment during the lease duration. The monthly depreciation fee is calculated as:

Part of the monthly lease payment that covers finance charges

The monthly lease payment consists of two components: depreciation fee and lease financing fee. The lease financing fee is the finance charge to pay the leasing company for the use of its money. It corresponds to the interest payment in a loan. The monthly lease financing fee can be approximated based on the average amount to be financed and based on the monthly interest rate as described in the formula below. The leasing company may simplify the calculation by using the money factor.

Monthly payments for the loan

Sum of discounted cash flows

Discounted cash flows are present values of cash flows, whether in- or outflows. When comparing different investment options with varying levels of cash flows in varying time periods, NPV calculated with the appropriate discount rate is the best measure to compare these options. Usually, an investment project where positive numbers represent cash inflows should be accepted if NPV is greater than zero. In cases where NPV is used to compare total costs where positive numbers represent cash outflows, like in FinanceIsland's lease-or-buy calculator for example, an investment with the lowest NPV should be selected. You can find more information about NPV and other financial metrics in this post on FinanceIsland's blog.

see Discount rate

Number of periods it takes until the cumulative cash flow becomes positive

Investment projects are accepted if the payback period meets some predefined cutoff period. Since this cutoff period is chosen arbitrarily, the payback period is a subjective measure. It simply ignores any cash flows after the cutoff. It also doesn't take the time value of money into account. You can find more information about the payback period and other financial metrics in this post on FinanceIsland's blog.

Discounted value of future cash flows

Present value is calculated based on a discount rate that takes into account that a dollar today is worth more than a dollar tomorrow and that a safe dollar is worth more than a risky dollar. You can find more information about time value of money and safe dollar on FinanceIsland's blog.

Describes how likely it is that a measure will take on a particular value

A probability distribution is an input into Monte Carlo simulation. There are dozens of probability distributions in statistics, but there are only few that are relevant for business. You can find more information about probability distributions in FinanceIsland's Monte Carlo simulation tutorial.

Present value of future cash flows divided by the initial investment

The profitability index (also referred to as the benefit-cost ratio) can also be calculated as NPV divided by the initial investment plus one. Usually, an investment project should be accepted if PI is greater than 1. You can find more information about the profitability index and other financial metrics in this post on FinanceIsland's blog.

Component of the Capital Asset Pricing Model (CAPM) that represents the discount rate for risk-free investments (see also FinanceIsland's Risk & CAPM tutorial)

Displays how sensitive a metric is to its drivers

The sensitivity chart is created by changing the value of each driver by a specified percentage amount while keeping all other drivers at their original values. The chart is usually displayed as a horizontal bar chart where the bars represent a range of possible metric values for each driver. The drivers with the widest bars have the biggest impact on the metric and should be analyzed in more detail. With the different width of the bars, the chart often resembles a tornado, hence it is also referred to as tornado chart.

Metric for measuring the spread in a data set (see also FinanceIsland's basic statistics tutorial)

see Sensitivity chart

Sum of the monthly depreciation fee and the monthly lease financing fee