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Deferrals Definition

Deferrals Definition

A deferral is used in accrual based accounting when an asset or liability has not been realized. It is recognized however because it will be recognized at a future date. Often times a deferral refers to a revenue or expense.

Deferrals Meaning

There are generally two types of deferrals in accounting.

The first, deferred revenue, is considered a liability because usually a service needs to be performed or a product must be delivered before the amount can be realized. This would happen if a customer paid for a product upfront with the guarantee that the company will deliver in the future.

The second is a deferred expense. It is often considered a liability because it is considered cash in the company’s pocket that does not have to be paid yet. Often times this extra cash can be put into short term securities to earn extra for the company. The most common deferred expense though are deferred taxes. This is an amount owed to the IRS, but not for a while. Therefore the company can earn extra cash from interest until they need to pay the amount. The money-generating ability of these deferred expenses is what makes them a liability on the balance sheet.

Deferral Example

King Company is in the business of producing toy crowns. In mid-April, King Company received payment from one of its many toy retailer customers. King has set up a plan with its vendors to pay them on a quarterly basis for plastic and other materials. Therefore, King has decided to invest the amount in short term securities until the payment to its vendors comes due at the end of June. Thanks to the lag time in deferrals King company is able to make an extra almost free profit based off of interest rates for two and a half months before its payment at the end of June.

deferrals definition

See Also:
Deferred Income Tax
Accrual Based Accounting
Accounting Principles
Generally Accepted Accounting Principles (GAAP)
Financial Accounting Standards Board (FASB)

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Economic Indicators

See Also:
Consumer Price Index
Stagflation
Balance of Payments
What are the Twin Deficits?
The Feds Beige Book

Economic Indicator Definition

Economic indicators are macroeconomic data that describe the condition of an economy. Use them to determine whether an economy is prosperous and expanding or troubled and contracting.

For example, a high unemployment rate and a contracting GDP are considered signs of a troubled economy, such as a recession. In comparison, high levels of consumer confidence and rising stock market indexes are signs of a prospering economy.

Economists, investors, and policy makers use economic indicators to discern the health of the economy. Then they try to forecast changes in the business cycle.

Types of Economic Indicators

There are three types of economic indicators: leading indicators, lagging indicators, and coincident indicators.

Leading indicators considered predictors of economic trends. Analysts use these data to try to forecast changes in the business cycle. Examples of leading indicators include the following:

  • Stock prices
  • Building permits
  • Average weekly initial claims for unemployment insurance
  • An index of consumer expectations

Coincident indicators fluctuate simultaneously with the business cycle and reflect the current condition of the economy. Examples of coincident indicators include the following:

Lagging indicators appear after the completion of economic trends and changes in the business cycle. Use them to analyze the economy in retrospect or to confirm other economic data. Examples of lagging indicators include the following:

Economic Indicator Sources

The most reliable and closely-watched economic indicators are published by government or non-profit organizations, such as the Conference Board, the Federal Reserve System, the Bureau of Labor Statistics, and other organizations. These organizations issue economic data periodically.

If you want to track your economic indicators, then download your KPI Discovery Cheatsheet today.

economic indicators

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economic indicators

Economic Data Online

Economic indicator data can be found at the following websites:

Conference Board Index: conference-board.org/economics

Federal Reserve System: federalreserve.gov

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Debtor in Possession

Debtor in Possession

A debtor in possession, or DIP, is a company undergoing a Chapter 11 bankruptcy reorganization. In Chapter 11 bankruptcy, the debtor remains in possession of its assets and continues normal business operations while reorganizing debt obligations and repayment plans. This is in contrast to a Chapter 7 liquidation, in which the debtor’s assets are sold to pay off debts and the bankrupt company ceases operations. In some cases, debtor-in-possession may refer to a legally appointed trustee, someone other than the actual company that is in bankruptcy, who oversees the assets during the reorganization.

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debtor in possession
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debtor in possession

See Also:
Chapter 11 Bankruptcy
Chapter 12 Bankruptcy
Bankruptcy Costs
Bankruptcy Courts
Chapter 13 Bankruptcy
Bankruptcy Code
Bankruptcy Information
Secrets of Successful Out of Court Debt Restructures
Tips on How to Manage your Lawyer
Relationship With Your Lender

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Economic Income Definition

See Also:
Economic Order Quantity (EOQ)
Accounting Income vs. Economic Income
Economic Production Run (EPR)
Problem With Days Sales Outstanding Example

Economic Income Definition

Economic income is the way for companies to account for changes in the value of a given asset in the market. It generally recognizes unrealized gains, in addition to recognizing realized gains.

A change in market value rather than cash received is the perfect example of an economic income. Economic income or loss recognizes all gains and losses whether realized or unrealized. This differs from accounting income which only recognizes realized gains: gains resulting from an actual business transaction. This defines the difference of accounting earnings vs economic earnings.

For income to be realized it must result from actual business transactions. A change in market value rather than cash received is economic income and not accounting income. When a gain or loss is unrealized it may or may not be accounted for in general. This depends on the placement of the gaining or losing asset in the balance sheet. Despite that this gain or loss may be accounted for, the fact that it is unrealized makes it an economic income or loss. The term economic income was born out of the need for financial accounting income vs economic income comparisons.

Economic Income and Time

Economic income assists companies in knowing the value of an asset if it was sold at a given time. Key to the economic income discussion is the current value of the asset. By then selecting a time period, research can estimate what price will be paid for the asset. This, as compared to estimations of market performance for the time period, can allow for projections of the market value of the asset in the future.

“If the current price of the land is $100,000 and we expect the market to increase by 10% next year, then the value of the land will be somewhere around $110,000 by the end of next year ($100k + $10k = $110k)”.

These measurements allow projections which influence decisions of financing, cash flow, insurance, timing of the asset sale, and other important decisions. Including costs in the decision can expand further to allow for net accounting income vs net economic income comparisons.

Economic Income Example

A perfect example of economic income occurs every day. Realco is a company which sells land. Realco purchased, last year, a piece of land for $100,000. The following year Realco notices the land is selling for $110,000. What is Realco’s economic income?

Realco has not sold the land. As a result it experienced an economic income of $10,000. This is proven by the fact that Realco did not have a transaction in which cash increased by $10,000. The economic income concept revolves around the recognition of income in spite of the fact that no sale has taken place.

If Realco sold the property, then it would have experienced an accounting income. Their land was sold for $10,000 more than initially worth. Thus, Realco has a realized gain of $10,000. The accounting earnings vs economic earnings calculation is the same: The difference is whether Realco gains $10,000 from the sale or not.

$110,000 (revenue from sale) – $100,000 (cost of land) = $10,000 (profit from sale)

economic income           accounting income

$10,000                   $10,000

In addition to monitoring market value changes, economic income provides a place holder for an asset in company financials. This allows for managerial accounting income vs economic income decisions. Without economic income, you would only account for an asset when sold or purchased. Economic income allows the monitoring of an asset between the transaction. At the time of accrual accounting income vs economic income evaluations are not the most important matter. They do form an important issue, however, with the natural business cycle changes that result from time.

economic income definition

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Debt to Equity Ratio

Debt to Equity Ratio Definition

Debt to equity ratio defined as an indication of management’s reliance to finance its asset on debt rather than on equity. It measures a company’s capacity to repay its creditors. This ratio varies with different industry and company. Comparing the ratio with industry peers is a better benchmark.

Debt to Equity Ratio Meaning

The debt ratio means an indication of the gearing level of a company. A high ratio means that a company may be over-leveraged with debt. This can result in high insolvent risk since excessive debt can lead to a heavy debt repayment burden. However, when a company chooses to rely largely on equity, they may lose the tax reduction benefit of interest payments. In a word, a company must consider both risk and tax issues to get an optimal debt to equity ratio explanation that suits their needs.

Debt to Equity Ratio Formula

The debt to equity ratio formula is listed below:

Debt to equity = total debt / total equity

Calculation of Debt to Equity Ratio

Debt to equity ratio calculations are a matter of simple arithmetic once the proper information is complied. Debts will include both current liabilities and long term liabilities.

Equity will include goods and property your business owns, plus any claims it has against other entities.

For example, a company has $10,000 in total debt, and $40,000 in total shareholders equity.

Debt to equity = 10,000 / 40,000 = 0.25

This means that a company has $0.25 in debt for every dollar of shareholders’ equity.

Debt to Equity Ratio Example

For example, Shari has started a residential real estate company which has grown to success. Though the market is tough, Shari has protected her cash account in order to deal with what the future holds. Shari now needs to perform debt to equity analysis to make sure she has not become over-leveraged in her company. This could cause problems with bank loans, her company free cash flow, and more.

Shari contacts her controller for debt to equity accounting questions. She knows that there is no debt to equity calculator, so she is willing to wait for some concrete results.

$10,000 in total debt and $40,000 in total shareholders equity.

Debt to equity = $10,000 / $40,000 = $0.25

Her controller finds that she is in perfect standing. Her company, though near its limit, does not have too much debt. It has enough cash to survive common issues which face the residential real estate industry.

She is satisfied that she has followed the path of a responsible business owner. Because she is so used to putting out fires, she is content with the status quo of her company’s regular monthly profits. Shari looks forward to her next quarter.

Resources

For statistical information about industry financial ratios, please click the following website: www.bizstats.comand www.valueline.com.

If you want to add more value to your organization, then click here to download the Know Your Economics Worksheet.

debt to equity ratio

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debt to equity ratio

See Also:
Financial Ratios
Debt Ratio
Debt Service Coverage Ratio (DSCR)
Free Cash Flow

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EBITDA Valuation

See Also:
Valuation Methods
Success Is Your Business
Self-Liquidating Loans
What is dilution, how is it calculated, and how should you manage it?
Which Bank to Choose?
Calculate EBITDA
Adjusted EBITDA

EBITDA Valuation Method

There are multitudes of ways to value a company, as well as specific equity and debt claims on a company’s assets. One is the EBITDA valuation method, which relies on a multiple of EBITDA to arrive at a company’s enterprise value.

The definition of enterprise value is the total value of a firm’s equity and debt. It can also be thought of as the total market value of a company’s expected cash flow stream. A company’s EBITDA is a measure of that stream. Furthermore, EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back. It is not an exact measure of a company’s cash flow, but it is one which has gained wide acceptance in the banking and investment communities.

Use the following enterprise valuation formula:

Enterprise Value = Multiple * EBITDA

where EBITDA is typically projected for the next twelve months. Sometimes, the amount used is the actual EBITDA of the company over the last twelve months. Label it as “LTM EBITDA.”

EBITDA Valuation Multiple

Base the multiple on comparable actual sales transactions occurred recently in the company’s industry. Often, one will use the derived multiples of publicly traded companies in the industry in addition to or in lieu of actual transactions.

Also, while you may use a single value for the EBITDA multiple, you often get a range. This range is based on the distribution of comparable multiples, with abnormally high or low multiples excluded so as to provide a useful range for the end user of the valuation.

Valuing Equity Using the EBITDA Valuation Method

Use the EBITDA valuation method to value a company’s total equity. After arriving at the company’s enterprise value using the formula described above, subtract the net debt of a company to determine the value of the equity claim on the firm’s total cash flow. Methods used to directly value equity adjust the firm’s cash flow to yield the cash flow available to shareholders. This is also known as “Free Cash Flow to Equity.”

Use the following formula to value equity using the EBITDA valuation method:

Equity Value = Enterprise Value – Total Debt – Cash and Cash Equivalents

Problems with the EBITDA Valuation Method to Value Equity

The primary problem is that this method relies on EBITDA as a measure of a firm’s cash flow, ignoring other significant factors which can impact a company’s cash flow, such as changes in working capital and capital expenditures. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

ebitda valuation

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EBITDA Formula

EBITDA Formula

In order to completely understand the concept of EBITDA, an intelligent idea is to visualize the formula concept. Express the EBITDA calculation formula as follows:

EBITDA = Revenues – Costs (excluding interest expenses, taxes, depreciation, and amortization)

or, if a person wants to view EBITDA in terms of the excluded expenses listed above, another way to calculate EBITDA is: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

EBITDA Ratio Analysis

Use EBITDA in accounting ratios that compare the profitability of different companies in the same industry. It is important to have a preferable EBITDA so that you can make positive estimates about your company for the future. At the same time, it is just as important, if not more so, to have a positive EBITDA for outside observers. For example, a ratio used to compare profitability is the EBITDA margin ratio. Calculate it using the following equation:

EBITDA Margin Ratio = EBITDA/Sales

The idea is that excluding interest, taxes, depreciation, and amortization gives a clearer picture of a company’s operating performance. More specifically, a company can be viewed with no stings attached using the calculation of EBITDA. Essentially, EBITDA is the skeleton and necessary structure functions and costs of the company. Also use EBITDA to measure the ability of a company to service its interest bearing debt, through the use of the EBITDA coverage ratio. Calculate EBITDA coverage ratio using the following equation:

EBITDA Coverage Ratio = EBITDA/Debt Service

EBITDA Valuation

Value companies using a EBITDA valuation multiple. Calculate the enterprise value of a company using a multiple of its annualized EBITDA. Express this as:

Enterprise Value (EV) = Multiple * EBITDA

where the multiple is derived from an average of comparable transactions in the company’s industry. To use this method to value a company’s equity, subtract the company’s total debt less cash (known as net debt) from its enterprise value:

Equity Value = Enterprise Value – Total Debt – Cash

If you want to find out more about how you could utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet. Shape your economics to result in profit.

ebitda formula

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ebitda formula

See Also:

EBITDA Definition
EBITDA Valuation

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