A company’s operating cycle is the number of days, on average, between the acquisition (or production) of inventory and the eventual sale of that inventory.  A company’s operating cycle is the sum of two metrics: days sales in inventory and days sales outstanding.   Days sales in inventory (DSI) indicates the average number of days to […]

Net income refers to a company’s revenues less all expenses.   Net income is also called net profit. A company generates a net profit when its revenues are greater than its expenses. A company generates a net loss when its expenses are greater than its revenues.  Net income differs from gross income in that gross income

Liquidity refers to the ability to convert assets to cash without significant impairment.   An asset which can be sold quickly without impairment is said to be highly liquid. An asset which cannot be sold quickly, or which can only be sold quickly at a significant discount to the asset’s fair value, is said to be

A limited liability company (LLC) is an entity formed under state statute which provides limited liability to its owners. Laws governing LLCs vary from state to state.  LLC owners are called members. These members can be individuals or other entities. Many LLCs designate a manager – either an individual or an entity – to oversee

Liabilities are obligations the company has to provide goods, services, or payment to third parties.   Liabilities appear on the balance sheet under the ‘liabilities and equity’ section. Liabilities are recorded at the amounts at which the liabilities are expected to be settled. Often, these settlement amounts must be estimated.  Liabilities are classified as current or

Operating leverage is a measure of the amount of fixed costs relative to a company’s total cost structure.   Fixed costs are those costs which do not fluctuate proportionally with sales. In contrast, variable  costs are those costs which do fluctuate with sales. The company’s total cost structure is the sum of fixed and variable costs.  

Financial leverage refers to the amount of borrowed money (debt) a company uses to finance its assets.  Debt is referred to as financial leverage because it acts as a fulcrum, magnifying the amount of gains or losses on an equity investment. For example, suppose that a real estate development company invests $10 million into a

The double-declining balance method is an accelerated method of depreciation in which depreciation is recognized at twice the rate recognized under the straight-line method.  The double-declining balance method is one of two most common methods of accelerated depreciation. The other accelerated method is the sum of the years’ digits method. Unlike straight-line depreciation, which recognizes

Gross profit refers to a company’s sales, net of discounts, returns, and allowances, minus the direct costs of selling goods and services.  The composition of direct costs will vary depending on the type of business. Retailing and wholesaling companies, for example, sell inventory in essentially the same form in which they purchased the inventory. The

Free cash flow is the amount of operating cash flow which remains after subtracting capital expenditures.   Free cash flow is a measure of a company’s residual cash profits. However, free cash flow differs from profit on the income statement in several respects. First, free cash flow incorporates the cash flow effects of increases in operating