Financial Terms Glossary

K

Key Performance Indicator

A key performance indicator or KPI is a quantifiable metric used by a business to assess performance. Target levels for these KPI's are frequently set and the company aims to either meet or exceed them.

The key performance indicators chosen will vary from industry to industry and depend on the operational and strategic goals of the firm. KPI's and the target levels are usually outlined in the annual report.

L

Large Cap

A large-cap (large capitalization) firm is one with a market capitalization of over $10 billion. This figure is an approximation and may change over time or be defined differently among different industries.

Letter Of Intent

A letter of intent is any written communication between two parties agreeing on the trade of a good or service, or any corporate action (merger, acquisition etc.). This letter usually outlines the specific quantities, prices and any other terms of the arrangement.

Leverage

Leverage is the use of borrowed money to enhance the returns of any investment. Using leverage, an investor is able to achieve the returns of a very large investment whilst only providing the capital for a small investment.

Unfortunately, as well as enhancing returns leverage will also magnify losses. An example of the pros and cons of leverage is below:

  • A hedge fund has $10 million of its own money
  • In year 1, the fund has a good year and returns 10%, or a $1 million profit
  • This is a 10% return on equity ($1,000,000 / $10,000,000)
  • In year 2, the fund borrows $90 million in the money markets and has to pay $5 million per year to service the debt
  • The return in year 2 is 10% again, or $10 million
  • After subtracting the $5 million to service the debt, total profit is $5 million, which is 50%, return on equity ($5,000,000 / $10,000,000)
  • Simply by using borrowed money, the fund has increased its returns from 10% to 50%
  • In year 3 the market turns against the fund, and they experience a loss of 10%
  • This is a loss of $10 million, plus the $5 million to service the debt, which is a total cost of $15 million. This is more than the $10 million of equity in the fund, so it is bankrupt
Liability

A liability is any debt that is owed by a firm, individual or country. Liabilities detract from value and are used to finance assets.

All liabilities are listed on a company's balance sheet and are defined as either current (held for less than one year) or long term (held for more than one year). The most common kinds of liability found on a balance sheet are listed below:

Current Liabilities

  • Accounts Payable
  • Accrued Expenses

Long Term Liabilities

  • Deferred Long Term Revenue
  • Long Term Debt
Liquidation

Liquidation is the act of selling off an asset for cash. It is usually a last-resort approach when a firm desperately needs money to pay off its debt or liabilities and has no other means of doing so.

Some assets are more preferably for liquidation than others. Assets that are invested for the long term usually have some form of penalty associated with early withdrawal and therefore the amount recovered would be less than the firm put in, requiring even more liquidation.

Another problem is that when a company liquidates assets, it usually means the company is in financial trouble. This causes panic in the markets and those assets devalue, which means more assets need to be liquefied, which further lowers prices, creating a vicious cycle.

Long

Long is a term used in trading to denote owning an asset and profiting when it's value goes up. This is the most common way to own assets, as it can be tricky to be short (profit when the asset goes down).

Being long is done by buying the asset, and therefore gaining money when the asset increases in value and losing money when it decreases.

An example of how the word long is used is:

  • I'm long on US Treasury Bonds

This means the investor owns US Treasury Bonds and is expecting them to go up in value and thereby earn a profit.