12 finance terms you should know to navigate money: Part 1
The more you learn about money, the easier it becomes to handle. Whether you’re making your first investment or looking to expand your financial knowledge, here are 12 financial terms you need to know to master money.
Imagine you’re about to embark on a journey to a distant and exotic land. As you take your first steps, you're greeted by a foreign environment—language, food, clothes, and more. Each word is a brushstroke of meaning that you must understand to live there.
Similarly, the world of finance is an exotic land that permeates our everyday lives. Understanding the language or knowing financial terms can help you navigate your way effectively.
Financial literacy holds the key to unlocking the power of smart monetary decisions. Whether you're a budding investor, an aspiring entrepreneur, or simply someone seeking to secure a stable financial future, knowing basic financial terms will give you more control and help you get started on your journey.
In this article, we will go through top financial terms you need to know.
Additional read: Here’s a story about Her Haq, a Delhi-based NGO that promotes financial literacy, among other things, for women
Assets are anything that can provide you with a monetary benefit in the future. For individuals, items such as a house, land, gold, fixed deposits, and cash can be considered as assets. For businesses, assets could be real estate, plant and machinery, inventory or products, and even trademarks and patents. The more assets that you own, the better your financial position in the future.
If assets are items that you own, liabilities are things you “owe”. In other words, if you have to pay back anything, be it an education loan or a mortgage, it is a liability. For individuals, a liability could encompass loans, debt, or credit card payments. For businesses too, loans and debt are liabilities, along with payments due to suppliers or vendors and even wages.
While often people assume that liabilities are a financial burden, they are necessary for you to grow. For instance, you may not be able to get a house without taking out a mortgage. In turn, the home becomes your asset in the long term. Similarly, businesses may need loans for growth, research, or to buy plant and machinery.
A debt is a form of liability. Any money that you owe to a borrower is a debt. It has to be paid back, along with an interest. There are many forms of debt such as loans and bonds. Good debt has the potential to increase your wealth in the long term. Yet, you should know how to effectively manage your debt in a way that it doesn’t weigh on you financially.
A loan is a form of debt wherein one party borrows money from another party (i.e. the lender). You must often repay a loan along with interest. In common financial parlance, debt and loans are basic financial terms that are used interchangeably. However, there is a small distinction between the two.
Debt is usually used in the context of business terms—any money borrowed through the issuance of bonds, debentures or other financial instruments is called debt. A loan, on the other hand, refers to a sum borrowed from a bank or a financial institution.
Equity refers to the value of shares that investors own in a company. In other words, it is the percentage that someone else owns in a company and needs to be compensated for. In financial terms, equity is equal to assets minus liabilities. When someone owns equity in a company, they are eligible to a share in the profit in the company in proportion to their investment.
When you invest in shares of a company, you become an equity owner and you receive returns in the form of dividends or an increase in the share price.
Income is any money that comes to you in exchange for labour or the sale of products and services. Income can also be anything you generate from your assets. For instance, individuals make income through their work, rent from house or property, or investments. Companies generate income by selling their goods and services, as well as through returns on their assets.
Gross income is the total money that comes into your account during a given period. Net income is the amount of money left over after cash outflows or payments. Also, income is considered for a specific period of time, such as a month, a quarter or a year.
An expense is the opposite of income. Any cash outflow is considered an expense. This too is calculated for a specific period of time, such as a month or a year. For individuals, rent payments, utilities or grocery payments are expenses. For companies, wages or the purchase of raw materials are expenses.
8. Balance Sheet
A balance sheet is an important financial term to know if you make investments in stocks or businesses. It is one of three main financial statements that a company must put out. It is a summary of a company’s financial position.
It shows the assets, liabilities and equity of a company in a nutshell–the assets on one side and liabilities and equity on the other. The assets and liabilities plus equity on a balance sheet must always be equal. Learning to read a balance sheet is important for you as an investor.
Additional read: Learn about what revenue and profit are in this primer.
Anyone who makes investments in assets must know what depreciation is because it is one of the most basic finance terms. The decrease in the value of an asset over time is called depreciation. As an individual, a depreciating asset means that you lose some value of the asset over time. For instance, a car is a depreciating asset. Over time, the value of your car reduces.
As a business term, depreciation means the same thing, but it is important in terms of accounting. Depreciation is allocated over the useful life of an asset as an expense. For instance, the value of a piece of equipment may be around Rs. 20,00,000 at the time of purchase. Assume that it has a useful life of 5 years. Every year for the next five years after its purchase, depreciation of Rs. 5,00,000 will be deducted from the asset’s value on the balance sheet.
A budget is a financial plan for a particular period of time. Both individuals and companies benefit from creating a budget. From the perspective of companies, a budget is a comprehensive list of how money will be spent on various activities such as wages and salaries, production, sales, marketing, etc. Understanding the budget of a company for a year makes it easier to estimate how much money will be spent versus how much money it expects to generate.
From an individual’s point of view, a budget is a financial plan for a month or a year. It helps understand your income and expenses and make a plan that will allow you to be financially prudent.
11. P/E ratio
P/E ratio or Price to Earnings ratio is a crucial financial term to know if you want to invest in stocks or a business. The P/E ratio tells us the value of a company’s stock. Think of it like checking the price tag of a product and trying to understand its value in your life. It is calculated as the current market price of the share divided by its earnings per share (EPS). The earnings per share is the company’s profit divided by the number of shares it has issued in the market.
A P/E ratio is never considered in isolation. It is always compared with an industry average or other peers. A company with a high P/E ratio means that investors in the market think of it as valuable and are willing to pay a high price for it. A low P/E ratio compared to peers indicates that either the company is undervalued or the market has low expectations for the company in the future and investors are not willing to invest in it.
ROI or Return on Investment is another important financial metric to know that measures how profitable an investment is. In other words, it helps to assess what your returns will be on an investment. ROI can be calculated for any asset, but it is vital to understand ROI before you invest in a company or a business.
To calculate ROI, you divide the gain or profit from an investment by the initial cost of the investment. This figure is usually expressed as a percentage. The higher the ROI, the better your investment is performing.
The path to financial literacy
Understanding basic financial terms is essential to embark on the journey of financial literacy. Armed with these terms, you will be able to read financial news better and understand what it means. You will also be able to make better investments.
Watch out for part 2 of our top financial terms to know more.