A more technical look at the terms I’m talking about. I’ll keep updating this page as I add more posts.
Accrual-Based Accounting
The opposite of cash-based accounting. It’s a requirement for companies who are on the Stock Exchanges around the world. Back to our banquet hall example, the cost of the wine would be considered an expense on the wedding day, when they actually open the bottles and serve them. You can see why small businesses with limited resources would rather stick with the cash-based approach - it’s much simpler for them to just record the cash when it changes hand.
Cash-Based Accounting
A simple approach to accounting that’s popular with small businesses. It means recognizing a revenue or expense when cash is exchanged. E.g. Say a banquet hall buys 100 bottles of wine for a wedding, and the bill has to be paid a week before the big day. Under cash-based accounting, the hall would consider the money an expense the day the bill is paid, even though it won’t actually use the wine until the wedding day.
Clustering
The geographic congregation of a group of merchants based on the similar products they’re selling. In business, there’s strength in numbers when it comes to attracting customers as a group and showing off a wide array of products. For example, we often see the clustering of businesses such as antique shops, car dealerships, or fashion boutiques. The customer benefits too, from a one-stop shopping experience. This, in turn, attracts even more businesses to the area.
Credits
An accounting entry that’s the opposite of Debits. A credit entry increases the liabilities and revenue, and decreases the assets and expenses. At the bottom line, the debit balances must equal the credit balances.
Debits
An accounting entry that’s the opposite of Credits. A debit entry increases assets and expenses, and decreases liabilities and revenue. At the bottom line, the debit balances must equal to the credit balances.
Demand
The quantity of a product that’s desired in the market at a certain price. If supply and demand are not equal to one another, then the price is adjusted to balance out the relationship. E.g. A high demand and a low supply mean higher prices.
Diminishing Rate of Return
A concept in economics that says that in some situations, as more units are produced, the marginal benefit from the last unit will continue to decrease. In another word, after a while it’s just not worth it anymore. The trick is to know when to stop before that happens. This concept is very important and groundbreaking because it shows that even in business, more is not necessary better.
Economy of Scale
A concept in economics that says that in some situations, as more units are produced, the marginal cost for the last unit will continue to decrease, leads to the fall of the overall average cost per unit. In other words, the more you make, the cheaper it gets on average. That’s why no one opens up a factory just to produce one toy. Figuring out the optimal output though, takes some good studies in economics.
Historical Trend Analysis
An analytical technique using historical data to predict future figures. It’s the belief that the past numbers form a trend, which continues onwards. By mapping and figuring out that trend, you could make accurate projections for future outcomes. If you look at just one point in history, there might be “noise” that distracts you. But if you look the whole history, an underlying pattern will emerge.
Market Collapse
A phenomenon that happens when the desires of two bargaining parties are so vastly different that no deal could be made. So both sides walk away without reaching any agreement. The market is said to have “collapsed.”
Market Value
The price a product/asset could commend in an open, fair, and competitive market.
Niche Market
A market that is specialized, boutique-styled, and fulfills the wants or needs of a certain segment of the population. The idea is that a product doesn’t have to have mass market appeal to turn a profit. All it has to do is have unique qualities that its customers are willing to pay good money for.
Opportunity Cost
The cost of choosing Project A over Project B, as defined by the loss of opportunity. Instead of just considering the hard cost of doing Project A, the real cost of the choice also includes the cost of not doing Project B. Though Opportunity Cost is often hard to measure (the could’ve beens), it is nevertheless very real, and it forms one of the most fundamental concepts in economics.
Portfolio Diversification
An investment strategy that says, quite simply put: don’t put all your eggs in one basket. That’s because at any point in time, some stocks will go up while the others go down. Since no one ever truly knows which will be which, buying a little bit of everything will yield the best overall return. Some of the good ones will cancel out the bad ones, and your risk exposure is reduced.
Project Horizon
An analysis of a project based on its duration, by mapping out the timeline of its cash outflow verses cash inflow. There are many types of ventures: long-term, short-term, etc. Before taking on a project, a company needs to examine what type it is, and review that timeline carefully. Many promising small companies fail because they aren’t able to survive long enough for the payday.
Risk & Reward
The idea that the potential benefits one gets from a venture go hand in hand with their potential costs. Generally the higher the reward, the higher the risk, and vice versa. That’s what motivates people to join in the game.
Salvage Value
The residual value of an asset that has gone obsolete. It’s the small sum of money you could get by selling an asset at the end of its useful life.
Set-Up Cost
The upfront cost of starting a business. To get a venture off the ground, there are usually costs that need to be paid right in the beginning. This could be in the form of obtaining heavy machinery, a factory building, advertisement, etc. Once everything is set up though, the cost to keep it going is significantly less. The inability to pay the Set-Up Cost is what stops a lot of business ideas in their infancy.
Signalling
The act of sending a message to the market through one’s own behaviours. It’s not what you say, but what you do, that people really take heed. Companies take certain actions on purpose in order to show outsiders its outlook. E.g. The market assumes that as a logical being, the company wouldn’t spend on R&D unless it has an ace up its sleeve. Therefore, the company will be valued as winner.
Substance over Form
An accounting principle that’s used to determine the real financial picture of a company. In recording transactions, accountants are taught to look beyond an asset’s legal value. That is because values are defined rather differently in legal and accounting terms. What looks good on paper might not be as real as you’d like, and it’s the accountant’s job to report the true nature of the transactions.
Supply
The quantity of a product that’s available in the market at a certain price. If supply and demand are not equal to one another, then the price is adjusted to balance out the relationship. E.g. A high demand and a low supply mean higher prices.
Tragedy of the Commons
The dilemma that arises when a group of individuals share a common pool of resources. In that situation, everyone will take the short-term gain for themselves, even if that would lead to long-term consequences that hurt everybody in the end.
Write Off
The act of taking an asset off the balance sheet, thus deeming it worthless. This is done by recording a loss on the income statement for the equivalent amount. Bear in mind, there’s a new income statement every year, but the balance sheet keeps carrying on. So the write off is a one-time hit for the long-term financial health of the company. The failure to do so is the downfall of many respectable companies.
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