Financial Terms Glossary

Below we have provided a glossary of terms based on repeated requests and questions about certain financial related terms.

Gearing

The most common use of the term ‘gearing’ is to describe the level of a company’s net debt (net of cash or cash equivalents) compared with its equity capital, and usually it is expressed as a percentage. So a company with gearing of 60 per cent has levels of debt that are 60 per cent of its equity capital. The gearing ratio shows how encumbered a company is with debt. Depending on the industry, a gearing ratio of 15% would be considered prudent while anything over 100% would be considered risky or ‘highly geared’. ‘Gearing’ is also used in a related sense to refer to borrowings by an investment trust that boosts the return on capital and income via additional investment. When the trust is performing well shareholders enjoy an enhanced or ‘geared profit’. However if the trust performs poorly then the loss is similarly exaggerated. Gearing can also refer to the ratio between a company’s share price and its warrant price.

Statement Of Account

A document, issued by a supplier to its customer, listing transactions over a given period, normally monthly. It will include details of invoices, payments received and any credits approved with a resultant balance payable by the customer.

Ordinary Shares

Ordinary shares represent the ownership of a limited company. Companies are incorporated with an authorised share capital Ð for instance 1,000 ordinary £1 shares. They do not have to issue all the authorised shares, but can issue as many as they like up to the authorised number. Once issued the shares can be traded either privately or on an exchange if the company has listed them. The price at which they trade will have nothing to do with the par value, but will be determined by market forces. Shares usually come with a right to vote at the companys Annual General Meeting, and an entitlement to a share of dividends declared. They are, however, unsecured, meaning that shareholders are last in the queue if a company goes into liquidation. Known as common stock in the US.

Preference Shares

Shares in a company which give their holders an entitlement to a fixed dividend but which do not usually carry voting rights. The important difference between preference and ordinary shares are:

1. The dividend on ordinary shares is uncertain and variable (high when the company does well, poor or non-existent when it does badly). Preference shareholders get a fixed dividend which, if not paid, usually accrues until it can be.
2. Each ordinary share usually carries a vote. Preference shares do not usually carry a vote unless dividends fall into arrears.
3. In the event of a winding up, preference shares are usually repayable at par value, and rank above the claims of ordinary shareholders (but behind bank and trade creditors).

Preference shares may be issued with the right of conversion into ordinary shares. These are called convertibles.

Input Tax

When a company that is registered for value added tax (VAT) buys goods or services from another supplier, VAT is charged and is currently 17.5% of the purchase cost. This is known as input tax. Similarly, when the company sells its own goods or services it charges its customers VAT at the same rate. This is output tax. Once a quarter, the company has to complete a VAT return, giving details of its input tax and output tax. The difference between output tax and input tax is payable to HM Revenue & Customs. If input tax is greater than output tax the company can claim back money from HMRC.

Alternative Investment Market

A market created for small, young and growing companies, operated by the London Stock Exchange as a regulated market of a Recognised Investment Exchange (RIE) and set up in June 1995. It replaced the Unlisted Securities Market (USM). The market provides an opportunity for companies to raise capital for expansion, a trading facility and a way of establishing a market value for their shares. The admission criteria for AIM are less stringent than for the main market.

IMRO

The Investment Management Regulatory Organisation aimed to protect investors by setting and promoting standards of Òintegrity, competence and solvencyÓ for the regulated firms. It was established under the 1986 Financial Services Act and was subsumed into the FSA in 2001, producing its last annual report in 2000.

Gilt-edged Stock

A stock of high quality companies or countries. More specifically, gilts are fixed income or index-linked bonds issued by the UK Government. The purchaser of a gilt is lending the government money in return for regular interest payments and the promise that the nominal value of the gilt will be repaid (redeemed) on a specified later date. It is not necessary to hold a gilt until its redemption as, like shares, they are tradable instruments their prices move in line with supply and demand, and fluctuations in the main influences on the market such as future interest rates and inflation.

Dividend

The distribution of part of a company’s earnings to shareholders, usually twice a year (quarterly in the US). In the UK, there is traditionally a main dividend and an interim dividend during a company’s accounting year. Normally, the dividend is expressed on a ‘per share’ basis, for instance – 3p per share. This makes it easy to see how much of the company’s profits are being paid out, and how much are being retained by the company to plough back into the business. So a company that has earnings per share in the year of 6p, and pays out 3p per share as a dividend, is passing half of its profits on to shareholders and retaining the other half. Directors of a company have discretion as to how much of a dividend to declare, and they do not have to pay a dividend at all. Indeed, for young growth companies making no profits dividends are not generally expected.

Disability Income Insurance

Insurance that provides an income to policyholders when they are unable to work due to an illness or injury. Disability payments to insured people, which normally commence after a set period (the elimination period), are usually tax free provided the premium payments are up to date.

Financial Planning

The service provided by a financial planner. This is a long-term service provided for clients that considers all their financial affairs and develops a plan to achieve their financial objectives. The plan would be regularly reviewed to ensure goals remain on target with modifications being made as necessary.

Financial Strength

The measure of a company’s solvency, looking at the relationship between its assets and its liabilities.

Double Taxation Relief

People resident and domiciled in the UK are liable to income tax from their worldwide income payable to the British tax authorities. Other countries operate similar taxation rules so that there could arise a situation where an individual is subjected to double taxation. Double taxation relief can be obtained when agreements exist between countries whereby tax already paid on income in a foreign country is offset against the same tax liability in the home country or vice versa.

Domicile

The country in which a person lives, for tax purposes. The choice of domicile can have a large impact on tax paid. Many foreigners in a country will be “resident non-domiciled”.

Insurance

A contract in which payment of premiums covers the insured against something that may, or may not occur. Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. For example, motor insurance covers the insured against accidents that may occur. In the UK insurance is differentiated from assurance (life assurance) that is protection against something that will inevitably occur.

Household Insurance

Insurance covering the structure or contents of a house. This type of insurance now tends to include the option of cover for additional items such as legal expenses. Also some companies now offer no claims bonuses similar to those given by motor insurance companies.

Junk Bonds

Bonds which offer high rates of interest but with correspondingly higher risk attached to the capital. In the US they carry a credit rating of BB and below. Junk bonds fell into disrepute in the late 1980s, and are now termed ‘high yield bonds’.

Equity Risk Premium

The extra return that stocks provide over government bonds to compensate for the short to medium-term market risk. It is the concept that justifies investment in stocks, where the capital is at risk, rather than gilt-edged bonds, the safest investment available, where the capital is not at risk provided the bonds are held until maturity. The theory goes that it is only worth investing in stocks if the return exceeds the return on gilts – otherwise, who would take on the extra risk?

Compound Interest

The process by which interest earned on an investment is added back to the amount invested, so increasing the amount of ‘principal’ on which further interest will be earned in future years.

Compounding is sometimes described as the miracle of investing. The fact is that if you reinvest income in your portfolio, you will end up with a much larger amount than if you spend the income as you go along because of the effect of compounding. But to allow compounding to work its magic, you have to start young.

Albert Einstein, when asked what he considered to be mankind’s greatest invention, replied ‘Compound interest!’

Polarisation

A principle of UK financial regulation stating that salesmen and advisers have to choose between being either completely independent or tied to the products of a single supplier. The aim is to make it clear to the customer on what basis someone is trying to sell them a financial product. Depolarisation, in 2004, allows an in-between arrangement, where a multi-tied distributor offers products and services from a panel of selected providers.

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