Reference
The 20 most important finance terms, explained in plain English.
The gradual write-down of an intangible asset (like a patent or goodwill) or the repayment of a loan over time. For loans, each payment covers both interest and a slice of principal β early payments are mostly interest; later payments are mostly principal.
Example
A Β£200k mortgage at 5% over 25 years amortises so that in year 1, ~70% of each payment is interest; by year 20, ~70% is principal repayment.
The level of sales at which total revenue equals total costs β neither profit nor loss. Calculated as Fixed Costs Γ· Contribution Margin per unit. Understanding your break-even is the first step in any pricing or cost decision.
Example
A bakery with Β£5,000/month fixed costs, selling loaves at Β£4 with Β£2 variable cost per loaf (Β£2 contribution margin), must sell 2,500 loaves/month to break even.
The rate at which a company spends its cash reserves before generating positive cash flow. Gross burn is total monthly spending; net burn is spending minus revenue. Critical for startups to track β it directly determines runway.
Example
A startup with Β£500k in the bank spending Β£80k/month in costs and earning Β£30k/month has a net burn of Β£50k/month.
Interest calculated on both the initial principal and the accumulated interest from previous periods. Often called the eighth wonder of the world β it turns small, consistent contributions into significant wealth over time. The earlier you start, the more powerful the effect.
Example
Β£10,000 invested at 8% p.a. becomes Β£46,610 after 20 years. At 30 years it's Β£100,627 β more than double the 20-year figure for just 10 extra years of patience.
The actual movement of money in and out of a business over a period. Unlike profit (which is an accounting concept), cash flow is real. A profitable business can go bankrupt from poor cash flow. The three types are operating, investing, and financing cash flows.
Example
A consultancy invoices Β£50k in December but isn't paid until February. On paper it's profitable in December, but its bank account is empty β a cash flow gap that must be managed.
Revenue minus variable costs β the amount each unit sold contributes toward covering fixed costs and generating profit. It is the building block of break-even analysis and pricing decisions. As a percentage of revenue it is called the Contribution Margin Ratio.
Example
Selling a product at Β£80 with Β£30 in variable costs gives a Β£50 contribution margin (62.5% CMR). Every unit sold contributes Β£50 toward the Β£10,000 fixed cost base β you need 200 units to break even.
A valuation method that estimates what a stream of future cash flows is worth today, by discounting them at a rate that reflects risk (typically WACC). The core idea: a pound today is worth more than a pound tomorrow. DCF is the most rigorous way to value a business or investment.
Example
If a business will generate Β£100k of free cash flow each year for 5 years, discounted at 10%, the present value is roughly Β£379k β not Β£500k β because future cash is worth less today.
A measure of a company's core operating profitability, stripping out financing decisions (interest), accounting policies (depreciation, amortisation), and tax. Widely used as a proxy for cash generation and for valuing businesses via EV/EBITDA multiples.
Example
A company with Β£500k revenue, Β£200k cost of goods, Β£100k salaries, and Β£30k depreciation has EBIT of Β£170k. Adding back depreciation gives EBITDA of Β£200k.
Operating profit β revenue minus all operating costs including depreciation, but before interest expense and income tax. It measures a company's profitability from core operations, independent of how it is financed or where it pays tax.
Example
A company earning Β£1m in revenue with Β£700k operating costs and Β£50k depreciation has EBIT of Β£250k. Whether it has debt (and pays interest) doesn't affect this number.
Revenue minus Cost of Goods Sold (COGS), expressed as a percentage of revenue. It measures how efficiently a business turns sales into profit before overhead. SaaS companies typically have 70β90% gross margins; manufacturers often 20β40%.
Example
A product selling for Β£100 with Β£35 in direct costs has a gross margin of (Β£100 β Β£35) Γ· Β£100 = 65%. This 65p of every pound goes toward paying fixed costs and eventually profit.
The discount rate that makes the Net Present Value (NPV) of all cash flows from an investment equal to zero. In simple terms: the annualised return you're expected to earn. Compare it to WACC β if IRR > WACC, the investment creates value.
Example
Investing Β£100k today and receiving Β£140k in 3 years gives an IRR of roughly 11.9%. If your cost of capital is 10%, this investment is worth making.
Using borrowed capital (debt) to amplify potential investment returns. Financial leverage magnifies both gains and losses. A Debt-to-Equity ratio above 1x is considered leveraged; above 3x is considered highly leveraged and riskier.
Example
Buying a Β£200k property with Β£50k equity and Β£150k mortgage is 3x leverage. A 10% rise in property value (Β£20k) is a 40% return on equity β but a 10% fall means losing 40% of your equity.
How quickly and easily an asset can be converted to cash without losing value. Cash is perfectly liquid; real estate is illiquid. For businesses, the Current Ratio (Current Assets Γ· Current Liabilities) measures short-term liquidity β below 1.0 is a red flag.
Example
A company with Β£200k cash, Β£100k receivables, and Β£150k payables has a current ratio of 2.0 β healthy. If it had Β£400k payables instead, current ratio drops to 0.75 β dangerously illiquid.
The sum of all future cash flows from an investment, discounted back to today, minus the initial investment. A positive NPV means the investment creates more value than its cost of capital; negative means it destroys value. It is the gold standard capital allocation metric.
Example
A project requires Β£50k upfront and generates Β£20k/year for 3 years. At a 10% discount rate, the PV of inflows is Β£49.7k. NPV = Β£49.7k β Β£50k = βΒ£300, meaning you'd just barely not make your hurdle rate.
A stock's share price divided by its earnings per share (EPS). It tells you how much investors are willing to pay for each pound of earnings. A high P/E suggests high growth expectations or overvaluation; a low P/E may indicate undervaluation or structural decline.
Example
A stock trading at Β£50 with EPS of Β£2.50 has a P/E of 20x. This means investors pay 20 times annual earnings β expensive for a utility, reasonable for a high-growth tech firm.
The number of months a company can continue operating before running out of cash, assuming no new revenue or funding. Calculated as Cash Reserves Γ· Net Burn Rate. 18 months is often cited as the minimum comfortable runway.
Example
The startup above with Β£500k cash and Β£50k/month net burn has 10 months of runway. They need to raise, grow revenue, or cut costs within that window.
A simple percentage measure of the gain or loss from an investment relative to its cost. ROI = (Net Profit Γ· Cost of Investment) Γ 100. It's quick to calculate but ignores time β use IRR for multi-year comparisons.
Example
Spending Β£10k on a marketing campaign that generates Β£35k in new revenue (with Β£15k variable costs) yields a net profit of Β£20k and an ROI of 200%.
The percentage of take-home income that is saved or invested each month. It is one of the most powerful levers in personal finance β it determines how fast you build wealth and how long until you achieve financial independence. Most financial advisers target 15β20%.
Example
Earning Β£4,000/month and saving Β£800 gives a 20% savings rate. Increasing to 30% (Β£1,200/month) invested at 8% p.a. can cut the time to financial independence by over a decade.
The blended rate a company must earn on its assets to satisfy all its investors β both debt holders and equity shareholders. It weights each source of capital by its proportion in the total capital structure. A lower WACC means cheaper funding and a higher business valuation.
Example
If a company is 60% equity-funded (cost 12%) and 40% debt-funded (cost 5% after tax), its WACC is 0.6 Γ 12% + 0.4 Γ 5% = 9.2%. Any investment returning more than 9.2% creates value.
Current Assets minus Current Liabilities β the short-term liquidity buffer that keeps a business running day-to-day. Positive working capital means a business can meet its near-term obligations. Negative working capital is a warning sign unless in a business model like supermarkets.
Example
A business with Β£150k in stock, Β£80k receivables, and Β£100k payables has working capital of Β£130k. If payables jump to Β£250k, working capital turns negative.
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