Financial Terms

A Guide to Some Common Financial Terms

JOB TEST PREP TEAM

In this guide you will find an explanation to some common financial terms. These are
terms that you may see while preparing for a job and taking tests in the Finance
Sector. This guide includes brief and simple explanations as well as illustrations and
examples. Good luck!
 Table of Contents

Sales .............................................................................................................................. 1

Wholesale and Retail .............................................................................................................. 1

Markup and Markdown .......................................................................................................... 1

Profit ............................................................................................................................. 2

Fixed and Variable Costs......................................................................................................... 2

Tax .......................................................................................................................................... 2

Profits in Detail ....................................................................................................................... 3

Profit Margins ......................................................................................................................... 3

ROI (Return on Investment) ................................................................................................... 3

Cash Flow ..................................................................................................................... 5

Inflation ........................................................................................................................ 6

Consumer Price Index (CPI) .................................................................................................... 7

Other Indices .......................................................................................................................... 8

Interest ......................................................................................................................... 8

Compound Interest................................................................................................................. 9

Compounding - Other Applications ........................................................................................ 9

Market Share ............................................................................................................. 10

Stocks .......................................................................................................................... 10

OHLC ..................................................................................................................................... 10

Gross Domestic Product (GDP) ............................................................................... 11

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Financial Terms
Sales
The term Sales usually refers to the total amount of money earned by the company for its products
or services. Sales may often be referred to as Turnover.

Wholesale and Retail

Goods and services will usually go through a Supply Chain that starts with the manufacturer and
ends with the consumer.

Wholesale price – The price the product costs when sold in a large batch to a supplier (who will
then resell it to the next person in the chain).

Retail price – The price a single or small lot of the product will cost the end consumer.

Markup and Markdown

In general Markup and Markdown is the difference between the typical price of an item and the
price a particular seller will demand for it.

Markup – The amount added to the cost of a product in order to cover overhead and profit.

Markdown – The amount a price is reduced or discounted.

Markup and Markdown can be given as a percentage of the original price or as a difference
between two prices.

Example:
Two supermarket chains are competing on the sale of Rainoff Umbrellas. Buying 50 umbrellas costs
the chains £500 and both usually sell one umbrella at a price of £15. In other words, the wholesale
price of an umbrella is 500 ÷ 50 = £10, whereas its retail price is £15.

Let’s assume that Cheap-o decides to sell the umbrellas for a 10% markdown from the usual retail
price. This means the new price would equal: 15 × (100% − 10%) = £13.5.

If Max-Stop feels it will be more worthwhile to simply markup the wholesale price by £4 per
umbrella, then the new price would be 10 + 4 = £14.

 Turnover is a very general term that is used differently depending on the context. In most cases we can assume that
Turnover will mean sales.
The general meaning of the term turnover is to describe a rate of change (incoming vs. outgoing). For example the
turnover rate of employees refers to the rate at which employees leave a workplace and are replaced.

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Profit
In general Profit is the amount of money a company can take home after all expenses are
accounted for. Profit is calculated in the following way:

𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒

1

Where:

Revenue – The amount of money earned from sales.

Expenditure or Expense(s) – The total amount of money spent.

Example:
In January, Sam’s textile company sold 250 garments for £10 apiece. The cost of raw materials was
£4 per garment (which amounts to a total of 250 × 4 = £1,000). Sam also spent £500 on rent and
another £500 on salaries.

In this case, the company’s revenue is the amount of money earned from garment sales, which
equals 250 × 10 = £2,500. The company’s expenses are the total amount spent on raw materials,
rent and salaries, which amounts to £2,000. The company’s profit is therefore: 2,500 − 2,000 =
£500.

Fixed and Variable Costs

Expenses often appear in term of Costs. Costs can be separated into two general types:

Fixed Costs – Costs that do not change with the number of units produced.

Variable Costs – Costs related specifically to the product and therefore change with the number of
units produced.

In the example above rent and salaries are the fixed costs, and raw materials are the variable
costs. When calculating the variable costs, we will generally have to multiply them by a certain
number of items (in the example we have costs of £4 per item for 250 items, which equal costs of
£1,000 in total).

Tax
In general, Tax is a percentage of the amount paid for a certain item or the earnings made by a
certain company levied by the government.

There are many types of tax; some of the most common examples are the following:

Corporate Tax – The tax levied on the earnings or profits of a company (usually after all other
expenses are taken into account).

Income Tax – The tax levied on the earnings or income of an individual or company.

Consumption Tax – The tax levied on the sale price of goods. There are two common forms of
this tax: Sales Tax which is a percentage of the retail price paid in full by the consumer, and VAT

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(Value Added Tax) which is a percentage of the profit at each stage of production paid by the
manufacturer, the retailer or the consumer.

(For illustration see example below)

Profits in Detail
Profits may be calculated at different steps of a business, therefore we may have a few different
types of profits.

Net Profit/Income – The final calculation of profit (or income), which takes into account all costs
including Tax.

Gross Profit/Income – In general the amount of profit (or income) of a company (or individual),
before the removal of taxes.

Gross Profit may sometimes be calculated before the removal of additional expenses such as
Overhead (costs the company has that are not directly related to the manufacture of its goods or
services). In this case we will have an intermediate stage of profit called Operating Profit.

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑜𝑠𝑡𝑠 or 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑

2

(For illustration see example below)

Profit Margins
Profit Margin – a measure of the profit generated from revenue.

Profit (Revenue − Expenditure)

Profit Margin = or alternatively Profit Margin =
Revenue Revenue
3

ROI (Return on Investment)

ROI – A tool used to decide if an investment is worthwhile or to compare two or more investments,
the greater the ROI the more worthwhile the venture.

(𝑅𝑒𝑡𝑢𝑟𝑛 − 𝐶𝑜𝑠𝑡𝑠) 𝑃𝑟𝑜𝑓𝑖𝑡

𝑅𝑂𝐼 = or in terms of profit 𝑅𝑂𝐼 =
𝐶𝑜𝑠𝑡𝑠 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
4

Note: Profit Margin is the division of Profit by Revenue while ROI is the division of Profit by
Expenses.

Example:
John is interested in starting a new company. He has the choice between the following products:

Product Clothes Raingear Sportsgear

Raw Materials Costs £1,000 £1,500 £1,500
Other Costs £1,000 £750 £1,000
Revenue £2,500 £2,500 £3,000
Note: all details based on 250 units

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Corporate Tax is 10% of Gross Profit. There is a Sales Tax of 3% upon the consumer. Income Tax
is 5% (of Net Income/Profit).

• To calculate corporate tax for each endeavor we would first need to determine gross profit
(Revenue – Expenses) then multiply by 0.1 (or 10%). We could then remove the tax to get net profit.
Let us examine the Clothes option:

To find the gross profit we need to calculate revenue less costs. In our case we have revenue of
£2,500; we also have two sources of cost, raw materials (£1,000) and others (£1,000) for a total of
£2,000. Since: Revenue – Expenses [or costs] = Profit, we have: 2,500 – 2,000 = 500, so the gross
profit is £500.

We now can calculate tax by multiplying the £500 profit by the 10% tax rate: 500 × 0.1 = 50, so
corporate tax is £50.

Finally we can remove this tax to find net profit: 500 – 50 = 450, so net profit is £450.

The following table summarizes the results for all three options:

Product Clothes Raingear Sportsgear

Gross Profit £ 500 £ 250 £ 500
Corporate Tax £ 50 £ 25 £ 50
Net Profit £ 450 £ 225 £ 450

• We can now determine which venture is best by calculating profit margin and ROI.
Again, let’s take the Clothes option as an example:

Profit margin = profit ÷ revenue = 450 ÷ 2,500 = 0.18 or 18%.

ROI = profit ÷ expenses = 450 ÷ 2,000 = 0.225 or 22.5%.

The results for all three options are summarized in the following table:

Product Clothes Raingear Sportsgear

Profit Margin 18 % 9% 15 %
ROI 22.5 % 10 % 18 %

We can see from here that although the revenue from both Clothes and Raingear is the same, it
would be more profitable and a better investment for John to choose Clothes as its profit margin and
ROI are the highest.

• Assuming that John sells his product straight to the consumer we can calculate the price before and
after tax as follows:

First we need to calculate the price before tax by dividing the revenue by the number of units sold.
Continuing with the Clothes option, we have revenue of £2,500 and a total of 250 units (as indicated
in the note under the table). Therefore, we have a unit price of 2,500 ÷ 250 = £10 per unit.

We can then calculate sales tax by multiplying the unit price by the sales tax rate of 3%. To find the
price after tax we add the tax to the original price.

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Sales Tax would then be: 10 × 0.03 = £0.3 per unit.

The Price after tax would be: 10 + 0.3 = £10.30.

(We could also calculate VAT [at the same rate] by dividing net profit [which is the value added to
the consumer] by number of units, calculating tax on that and adding this tax to the original price
instead of sales tax).

The complete results are summarized in the following table:

Product Clothes Raingear Sportsgear

Price before tax £ 10.00 £ 10.00 £ 12.00
Sales Tax £ 0.30 £ 0.30 £ 0.36
Price after tax £ 10.30 £ 10.30 £ 12.36
(VAT) £ 0.05 £ 0.03 £ 0.05
(Price after VAT) £ 10.05 £ 10.03 £ 12.05

• Now, let us say that John employs Dave as Corporate Manager with half the gross profits for his
salary. We could calculate the Income Tax Dave has to pay and his Net Income:

First, we need to find Dave’s salary in each case by dividing the gross profit by 2. Next, we multiply
the result by the 5% tax rate to get the income tax. Finally, we can calculate the Net Income as
Income − Tax.

In the clothes example, Income = 500 ÷ 2 = £250.

Income Tax = 250 × 0.05 = £12.50.

Net Income = 250 − 12.5 = £237.50.

To summarize for all options:

Product Clothes Raingear Sportsgear

Income £ 250 £ 125 £ 250
Income Tax £ 12.50 £ 6.25 £ 12.50
Net Income £ 237.50 £ 118.75 £ 237.50

Cash Flow
Cash Flow refers to an individual’s or a company’s stream of cash coming in and going out over a
given period. Activities which increase the cash account (such as revenues and reception of interest
or dividends) will cause a Cash Inflow, while activities which decrease the cash account (such as
expenses, investments and payment of interest) will cause a Cash Outflow.

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Inflation
Inflation can be defined as the rate at which prices rise and purchasing power falls. As prices as a
whole increase, you can purchase less with each dollar you have.

Inflation is determined in terms of yearly percentage increase:

(𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑃𝑟𝑖𝑐𝑒 − 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒)

× 100
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒
5

Example:
If a movie ticket costs £10 and then there is inflation of 10%, the new price of the movie ticket will be
£11. In effect, you lost purchasing power; £10 previously afforded you a movie ticket and now it
does not.

Nominal Value – The nominal value of an item can be simply thought of as the number written on
the price tag. This number does not take inflation into account.

Real Value – The real value of an item is the value adjusted to account for inflation, and is thus
measured in terms of a certain reference year.

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑖𝑛 𝑌𝑒𝑎𝑟 𝐵

𝑅𝑒𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑖𝑛 𝑌𝑒𝑎𝑟 𝐵 =
(1 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑓𝑟𝑜𝑚 𝑌𝑒𝑎𝑟 𝐴 𝑡𝑜 𝑌𝑒𝑎𝑟 𝐵)
6

Where:
Year A – the earlier year
Year B – the later year

Example:
In 2014 Debbie earned a yearly salary of £50,000. Over the course of the year there was inflation of
100%.

If Debbie’s salary remains the same, its nominal value in 2015 will remain unchanged at £50,000.

To understand what happened to the Real value of her salary, let’s examine the effect of the
inflation. We are told that there was inflation of 100%, meaning prices as a whole increased by
100% and Debbie’s purchasing power from her £50,000 salary was cut in half. In other words, if in
2014 she spent her entire salary on a certain basket of goods, in 2015, after the effect of the 100%
inflation, the cost of that same basket will be £100,000 and Debbie can no longer afford to buy it.

Real Price Change – The change in price after taking inflation into account.

Real Price Change = NPEnd − [𝑁𝑃𝐵𝑒𝑔 × (1 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝐴𝐵 )]

7

Where:
NPEnd – Nominal Price at the end of the period
NPBeg – Nominal Price at the beginning of the period
InflationAB – Inflation from Year A to Year B

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Example:
• Let’s assume Debbie received a raise so that her new salary is £100,000. As we saw above, this
will allow her to purchase the same basket of goods she was previously able to buy with £50,000.
Therefore, the real value of her salary will remain the same.

This can also be seen using the above formula (at 100% inflation):

Real price change = £100,000 − [£50,000 × (1 + 1)] = £100,000 − £100,000 = 0

Conclusion: When the nominal value increases at the same rate as the inflation, there is no real
change in the value.

• Let’s say that Debbie received a 120% raise so that her new salary is now £110,000 (£50,000 × (1
+ 1.2) = £110,000). In this case, the real value of her salary increased as she can now purchase
more than just her previous basket of goods.

Real Price Change = £110,000 − [£50,000 × (1 + 1)] = £10,000.

Conclusion: When the nominal value increases at a greater rate than the inflation, there is an
increase in the real value.

• Finally, let’s assume that Debbie received an 80% raise so that her new salary is now £90,000
(£50,000 × (1 + 0.8) = £90,000). In this case, even though the nominal value of her salary
increased, the real value of her salary decreased as she can no longer afford her previous basket of
goods.

Real Price Change = £90,000 − [£50,000 × (1 + 1)] = -£10,000.

Conclusion: When the nominal value increases at a lower rate than the inflation, the real value
decreases.

Consumer Price Index (CPI)

Consumer Price Index – A measure that examines the weighted average of the prices of a basket
of goods and services.

The CPI is one of the most frequently used statistics to determine inflation or deflation. The CPI
increases when the overall price of goods and services increases (which indicates inflation), and
decreases when the overall price of goods and services decreases (which indicates deflation).

Calculating the inflation rate from the CPI can be done using the following formula:

𝐶𝑃𝐼𝐸𝑛𝑑 − 𝐶𝑃𝐼𝐵𝑒𝑔 𝐶𝑃𝐼𝐸𝑛𝑑

𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 = or more simply: 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 = ( )−1
𝐶𝑃𝐼𝐵𝑒𝑔 𝐶𝑃𝐼𝐵𝑒𝑔
8

Where:
CPIEnd – CPI at the end of the period
CPIBeg – CPI at the beginning of the period

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Example:
The table shows the CPI for several years.

Year CPI at End of Year

1 100
2 102
3 104
4 105

• If we want to determine the inflation in year 3, we need to calculate the increase in CPI from the
end of year 2 until the end of year 3 using the formula above:

Inflation rate = (104 ÷ 102) − 1 = 0.019 or 1.9%

• Assume that we want to calculate the real price increase of a house, whose price was £150,000 at
the end of year 2 and £160,000 at the end of year 4. In order to find the real price increase of the
house we can use the formula above:

𝑅𝑒𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = 𝑁𝑃𝐵 − [𝑁𝑃𝐴 × (1 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝐴𝐵 )]

𝐶𝑃𝐼
Since we also know above 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 = (𝐶𝑃𝐼𝐸𝑛𝑑 ) − 1, we can use the formula:
𝐵𝑒𝑔

𝐸𝑛𝑑 𝑜𝑓 𝑃𝑒𝑟𝑖𝑜𝑑 𝐶𝑃𝐼

𝑅𝑒𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒𝑌𝑒𝑎𝑟 𝐵 − [𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 𝑌𝑒𝑎𝑟 𝐴 × ( )]
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑃𝑒𝑟𝑖𝑜𝑑 𝐶𝑃𝐼
9

Therefore, the Real Price Change = 160,000 − [150,000 × (105 ÷ 102)] = £5,588.23

Other Indices
It should be noted that the CPI is a very commonly used index, but is not the only one. Other
commonly used indices, from which inflation can be derived, are the Retail Price Index (RPI) and
Wholesale Price Index (WPI). There are also price indices of specific branches of the market, such
as an automobile price index, or a price index for real estate. When solving tests, it is important to
notice the index relevant to the question.

To learn more about inflation, watch our dedicated video tutorial.

Interest
Interest – The fee paid to borrow money, which is generally calculated as a percentage of the
borrowed sum. This percentage is known as the Interest Rate.

Example:
Joe took a one year loan from Rob worth £100 with 10% annual interest. The total sum Joe will pay
Rob at the end of the year will be £100, plus an additional 10%. He will therefore pay Rob: 100 +
(100 × 0.1) = £110.

Notice that this can also be calculated as 100 × 1.1 = 110.

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Compound Interest
Compound Interest – The interest on the principal of a loan and on previously accumulated
interest. It can be thought of as interest on interest.

Example:
If Joe took a three year loan from Rob worth £100 with 10% annual interest, the total sum Joe will
pay Rob at the end of the three years is calculated as follows:

At the end of year 1 the amount that Joe will owe Rob is: 100 × 1.1 = £110 (as before).

Since the interest rate is annual and Joe has not paid back his debt yet, Joe will owe Rob an
additional 10% at the end of year 2. Remember, we defined compound interest as interest on
interest, therefore this amount will be calculated on the total outstanding debt including the interest:
110 × 1.1 = £121.

From the end of year 2 to the end of year 3 Joe will owe an additional 10%. This amount will be
equal to his total outstanding debt plus an additional 10%: 121 × 1.1 = £133.10.

Notice that the calculation we performed to find how much Joe repaid Rob at the end of a three
years loan of £100 with 10% annual interest is:

100 × 1.1 × 1.1 × 1.1, which is the same as: 100 × 1.13 = 133.1

Compound Interest occurs when the length of a loan is longer than the period over which interest
is accumulated. In such cases, the following formula should be used to calculate the total sum to be
repaid:

𝑃 × (1 + 𝑖)𝑛
10

Where:
P – Principal (The principal of a loan is the amount borrowed. In the example above the principal is
£100.)
i – Interest Rate
n – number of compounding periods

Compounding - Other Applications

Compounding commonly applies to interest, but can be applied to any other continuous percentage
changes as well, such as inflation and growth in sales. For example, in year 1, a company had sales
of £100,000, which grew by 7% every year. To calculate the sales of year 5 we would follow the
same principles and formula as above:

100,000 × 1.074 = £131,080

In the previous two examples the percentage change remained constant from year to year.
However, it is important to note that compounding can also occur when the percentage change
fluctuates. If in the example above the company’s sales grew by 1% in year 1, 2% in year 2, 5% in
year 3, and 6% in year 4, the sales in year 5 would be calculated as follows:

100,000 × 1.01 × 1.02 × 1.05 × 1.06 = £116,661

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Market Share
The Market Share of a company is the percentage of sales earned by a company relative to that
entire industry.

Example:
If in a given year, company A earns £5,000 from selling notebooks and £100,000 worth of
notebooks were sold that year in the industry, then company A has a market share of 5,000 ÷
100,000 = 0.05 or 5%.

Stocks
Stock – A share in the ownership of a company.

Example:
If company B issued 1,000 shares of stock, of which Sally purchased 200, then Sally owns 20% of
the company (200 ÷ 1,000 = 0.2 or 20%).

Dividend – A portion of a company’s earnings that is distributed to its shareholders.

Let’s get back to our Example:. If in 2014 company B declared a dividend of £10,000, then Sally
(who owns 20% of the company) will be entitled to 20% of the declared dividend and will receive
£2,000 (10,000 × 20% = 2,000).

Earnings Per Share (EPS) – The portion of a company’s profit allocated to each outstanding share
of stock. It can be calculated as:

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝐸𝑃𝑆 =
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠
11

In our Example:, if company B had a net profit of £500,000 in 2014, then its EPS equals 500,000 ÷
1,000 = £500.

OHLC
Data concerning stocks is often presented in an OHLC (Open High Low Close) table/chart, as can
be seen below:

A stock’s open is the price of the stock at the beginning of the day, and the stock’s close is the
price of the stock at the end of the day.

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The high of a stock represents the highest price point the stock reached over a given period of
time, and the low of a stock represents the lowest price point the stock reached over a given period
of time.

Gross Domestic Product (GDP)

GDP can be defined as the monetary value of all finished goods and services produced within a
region in a specific time period. It is used to measure the economic performance of a country or
region. If a country’s GDP grows over time, it indicates that the economy has been strengthening,
while if its GDP decreases over time, the economy is said to be in recession.

Example:

Figures are presented in £100 billions

If we analyze this data we will see that based on the GDP, in both 2013 and 2014 the US had the
strongest economy and Turkey had the weakest economy. We can further see that the United
States had the greatest growth from 2013 to 2014, with the GDP rising 29%. In these years, Turkey
appears to have been in recession as their GDP decreased.

Practice the financial concepts you have just read about with the
Finance drill found in the Numerical drills section in your pack.

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