Money. We all need it. We all want more of it. But sometimes, it can be difficult to get your head around how investments work with all the complex financial terms and concepts. Luckily, the team at Hippo.co.za is here to help. We went out and interviewed some of the brightest minds in the industry to get explanations on some financial and economic terms you may not understand.
Hanfred Rauch from customer experience company nlighten says that there are two terms that people often encounter (and misunderstand) in his industry:
Return on investment (ROI)
“This is the most misunderstood term in the financial industry – and the cause of much frustration. While the term is relatively simple to understand, for example, I’d like to spend R5 to get R10 back, many people don’t appreciate that this can sometimes only be quantified over a long period of time. For example, we’ve found that increased customer satisfaction can lead to a 30% increase in sales for businesses, but over a period of two years.”
The same applies to personal investments - – patience as a virtue is invaluable when it comes to getting the most bang for your buck.
“In business, acquisition broadly refers to one company taking over the operations of another. In terms of customer experience, it refers to the process of gaining new customers – especially at low cost. But many businesses lose sight of the fact that gaining a new customer is five times more expensive than retaining an existing one. From a customer experience standpoint, acquisition doesn’t begin and end with the act of gaining a new customer, but goes hand in hand with keeping your valuable existing ones.”
Christopher Botha from accounting platform QuickBooks says that the financial world can be a confusing one to navigate and that there are many terms that are often misunderstood.
“The dictionary definition of financial instruments is that they’re tradable assets of any kind. They can be cash, evidence of an ownership interest in an entity, or a contractual right to receive or deliver cash. But the reason this term is so misunderstood is that it’s incredibly broad, and people struggle to get their heads around it.”
Christopher notes that the term is mostly used during financial reporting, but that it should be understood by every business owner because ultimately, it refers to the most important element in any business: cash flow. “Without a genuine understanding of your cash flow, your business will ultimately fail,” he says.
Balance sheets, cash flow and entrepreneurship
“This leads us on to the balance sheet which is contentious because most people simply cannot read one.” Investors need to know how to use, analyse and read a balance sheet as it is an important tool to gain insight into a company’s financial position. A balance sheet is a financial statement that summarises a company's assets, liabilities and shareholders' equity at a specific point in time.
The balance sheet adheres to the following formula:
Assets = Liabilities + Shareholders' Equity
The total assets must equal the liabilities plus the equity of the company.
Assets can refer to cash (on hand or in the bank), inventory, accounts receivable or any equipment that is of value. Liabilities in turn are moneys owed by the business such as loans, interest payable, accounts payable, credit card debts, or taxes payable. Shareholders' equity is the initial amount of money invested into the business. Examples of equity would be opening investments, contributions, owner’s capital or retained earnings.
“Cash flow is another misunderstood term, as many companies see all incoming money as profit without factoring in their expenses,” Christopher says. Cash flow refers to the net amount of cash and cash-equivalents moving into and out of a business. Cash flow is increased by selling more goods/services, selling an asset, reducing costs, increasing the selling price, or taking a loan. The level of cash flow is not necessarily a good measure of performance. A business may be receiving massive inflows of cash, but only because it is selling off its long-term assets. It is thus important to view a company’s cash flow statement, balance sheet and income statement together.
Christopher says that people also struggle to understand the concept of entrepreneurship. “Entrepreneurship is not just about having a good idea, it is actually all about the successful execution of that idea,” he says. Entrepreneurship is the capacity and willingness to develop, organise and manage a business along with its risks in order to make a profit. Entrepreneurship is characterised by innovation and risk-taking.
Strate is licensed to be an independent provider of post-trade products and services for the financial markets. They gave us a few highlights from their glossary.
“Broker/Authorised financial services provider / Independent financial advisor is a person that is authorised to handle business and transactions on behalf of a client. A full-service broker operates in the financial sector and sells financial products such as insurance to clients. Brokers usually work on a commission basis and base fee on a percentage of the value of the transaction.”
“Refinancing is the process whereby a borrower takes out a new loan to pay off existing debt obligations. The person who applies for the new loan, usually pursues beneficial repayment terms such as a lower interest rate and monthly premium."
Here's an example of vehicle refinancing from Hippo.co.za: if you had bought a 2008 double cab that had cost you R 200,000 your monthly instalment would be R 4,650 over 72 months at a 16% interest rate. Refinancing it over the same term at 12% interest would yield an R 2,950 instalment, which is a staggering saving of R 1,700 per month.
Secured versus unsecured debt
“Secured debt is a type of loan that is backed by a legal claim on some specified property/collateral such as the borrower's car or home. When the borrower is unable to settle the amount owed, the lender will sell the property in order to cover the money owed. Unsecured debt is a high-risk loan that does not come with any collateral such as a Personal Loan or credit card. This type of debt only requires a good credit rating and often has a high interest rate due to the risk involved.”
“Securities include cash, shares, stock, debentures, debenture stock and bonds - any medium in which money is invested and through which businesses can acquire new capital.”
“Debt security, simply put, is investing in debt and refers to money that is borrowed and must be paid back according to the repayment terms and conditions that the two parties agreed upon. Debt securities are issued by governments and corporations and can be accompanied with or without collateral.
Equity security refers to ownership, such as stock or a trust that a shareholder has in a company. The owner has entitlement to the company's profits and assets based on the percentage of shares he invested in the company.
The rewards of these two types of securities differ: with debt security, the holder receives profit from interest rates and repayments; with equity security, the owner can benefit from capital gains – an increase of the value of an asset beyond its purchase price.”
“A unit trust can be regarded as a pool of assets consisting of shares, fixed-interest stocks and cash. The value of this fund is determined on a daily basis and divided into identical units each with the same value. The fund is held in trust for the investors by the trustee. For example, if you cannot afford shares on your own, you'll invest a lump sum in a unit trust which is a combined portfolio of other investors. The trustee will then award all investors an equal number of units which enables investors to buy shares in any sector in the South African economy – even without prior knowledge of investing or buying shares.”
“Income accrual refers to any interest and dividends which are received on shares and any other investments which are part of the investment portfolio of a fund.
Based on the accrual system of accounting, this term usually denotes income payable to an investor or revenue that has been accumulated but not yet been received by an individual or company. For example, the owner of an apartment block is expecting monthly rent payments from tenants on the first day of each month. On the last day of the previous month, the owner's accountant would make journal entries that acknowledge the payments due as ‘accrued revenue’ even though they have not yet received the money.”
Other general terms you need to know:
Credit rating or score
If you want to borrow money in any way, shape or form, such as through a Personal Loan, the company you are planning to borrow it from will take a look at your credit score, which indicates how likely you are to pay back the debt. This score is based on your personal credit history and looks at things like whether you’ve kept up with repayments on store cards or credit cards, for example. If you haven’t made these repayments, or missed some, then your credit score could be lower and this will affect your chances when it comes to being granted another form of credit.
Debt consolidation loan
Sometimes managing all your different forms of debt can get out of control, which is where a debt consolidation loan comes in handy. A debt consolidation loan is one large loan, which you take out with a single company, and enables you to pay off all your smaller liabilities in a way that is easy to manage - so you can get back on top of your debt.
Liquid assets are ones that are easy to convert into cash and will lose little to no value when they’re converted. Imagine you own an apartment block and suddenly needed that investment turned into cash? This would be an example of an asset that was not very liquid as you’d have to put it on the market, wait for a buyer and then wait to be paid. Liquid assets, on the other hand, are ones that can quickly be turned into cash, such as money in your bank account or unit trusts that you can sell.
Fixed assets are the opposite of liquid assets and are known as tangible assets. They are things you can see and touch like factory equipment, buildings, vehicles and computers. These are typically items that are not meant for resale but which a business uses in their day-to-day operations. Accountants use this term and concept to state assets in a business that depreciate over time, i.e., lose value.
This is a general term used to describe what a business owes. These could be long-term loans (like the one used to finance the business itself) or short-term ones like Personal Loans or accounts payable – which are also called current liabilities. Generally, current liabilities are those that are payable within a year.
The views and/or opinions expressed in this article are those of the authors and do not necessarily reflect the views of Hippo.co.za, its affiliates, or its employees. Hippo.co.za accepts no responsibility for losses incurred as a result of this article.