6.Glossary of Key Terms

Glossary of Key Terms

Capital expenditure: Capital expenditure, also known as ‘capex’, is incurred when a business spends money either to construct or buy fixed assets – like land, building, machinery, equipments, and vehicles – or to add value to an existing fixed asset, thereby extending its useful life.
Cyclical business: A cyclical business is one whose fortunes move in line with the economic cycle. So when the economy is doing good, this business sees good growth in sales and profits, and when the economy is doing bad, the business goes downhill.
Moat: Also known as economic moat, it is a term that was coined and popularized by Warren Buffett. It refers to a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms. A company tries to create moats (or competitive advantages) around its business so that its competitors cannot do it much harm. A company with a good moat is thus able to maintain good profit margins and high market share in the long term.
Operating cash flow: Operating Cash Flow or OCF (also known as “Cash Flow from Operating Activities”, or “Cash Flow from Operations”) is a measure of the total cash generated from a company’s operations. This figure is available in a company’s cash flow statement in its annual report. OCF tells how much cash a company has been able to generate from the operations of its business.
Since it adjusts for working capital and depreciation, it is a more accurate measure of how much cash a company has generated (or used) than measures of profitability such as net profit.
Free cash flow: To produce sales or operating revenue, a company incurs operating expenses. Like it spends money as salaries for employees, sales and marketing costs, and research and development costs. The difference between operating revenue, that is what the firm receives from customers on selling its products or services, and operating expense, the list of things above, is called Operating Income or Net Operating Profit (NOPAT).


Operating Revenue – Operating Expenses = Operating Income or Net Operating Profit (NOPAT)
Now, apart from the above-mentioned expenses, a company also must buy machinery, buildings, tools, and other things. It must invest money in real estate, buildings, and equipments. Also, the company needs to buy inputs for its production. It has to buy steel if it wants to produce cars. In financial terms, a firm has to purchase working capital to support its business activities. On top of that, a company must pay income taxes on its earnings.
The amount of cash that is left over after the payment of all these expenses, investments, and taxes is known as Free Cash Flow or FCF.


NOPAT – Change in Working Capital – Capital Expenditure = Free Cash Flow
Another way of calculating free cash flow is by simply reducing Capital Expenditure from Operating Cash Flow, two terms we have already discussed above. A high and rising FCF generation signals a company’s ability to pay debt, pay dividends, buy back stock and facilitate the growth of business – all important things from an investor’s perspective.
EBIDTA margin: EBIDTA is ‘Earnings before interest, tax, depreciation, and amortization’. It is also known as ‘operating profit’. It is calculated by reducing ‘operating expenses’ – or all expenses incurred in the day-to-day working of a business, from sales.


EBIDTA = Sales – Operating Expenses
You get EBIDTA margin when you divide EBIDTA by sales.

EBIDTA margin = EBIDTA / Sales
In effect, it is a profitability margin that shows how much of EBIDTA a company earns relative to its sales. EBIDTA margin is mostly used for comparison of a company’s profitability to competing businesses. Net profit: In simple terms, net profit is the money left over after paying all the expenses of business. It is calculated by subtracting a company’s total expenses from total revenue, thus showing what the company has earned (or lost) in a given period of time (usually one quarter or one year). It is also known as ‘bottomline’, ‘net income’ or ‘net earnings’.
Earnings per share (EPS): This is the figure you get by dividing a company’s net profit by its total number of issued equity shares. EPS is also the ‘E’ that you find in the P/E or price-to-earnings ratio.
Working capital: Working capital represents a company’s operating liquidity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities.


Net Working Capital = Current Assets − Current Liabilities