Glossary

Welcome to Fineco’s Glossary! It will help you better understand the financial terminology and master your financial skills.

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Reaganomics

Reaganomics is the set of conservative economic and tax policies propounded by former U.S. president Ronald Reagan and his administration in the 1980s. It calls for cuts to both taxes for individuals and business and to government spending. The idea is that the additional cash in private hands will stimulate new hires and investments and incentivise people to work, thus trickling down to all segments of society and ultimately expanding the tax base. Reaganomics was prescribed as a solution to stagflation, which is an economic recession combined with inflation.

Recession

A is recession a significant and sustained contraction of economic activity in a specific geographical area. There is no single standardized definition of a recession, but according to the National Bureau of Economic Research, an economic downturn must meet three criteria to be considered a recession: depth, diffusion, and duration.

Most economists do not consider a downturn a recession until it lasts for more than a few months. Key gauges of recessions include GDP decline, rising unemployment, and slumping retail sales and industrial production.

The opposite of a recession is an expansion, which is an economy’s habitual state. Meanwhile, a depression can be distinguished from a recession by its severity; for example, the Great Depression in the 1930s resulted in a nearly 30% drop in US GDP, while the Great Recession of 2007-2009 saw GDP fall by 4.3%.

Residual income

Residual income is the earnings left over after subtracting the opportunity cost of the capital used to generate those earnings. The opportunity cost is the amount of money that could have been made with that capital from a different investment with equivalent risk. Company managers use residual income as a decision-making tool and an internal measure of performance.

In personal finance, residual income means disposable income. It is the money a person has after paying his or her interest payments and expenses. Lenders calculate a borrower’s residual income to decide whether to grant a loan.

Residual value

The meaning of the term residual value varies depending on context. When evaluating investments, residual value means the profits minus the cost of capital (or in other words, the actual return minus the expected return for an investment with that risk level). In the field of accounting, residual value is a synonym of salvage value, or the remaining worth of an asset after it has completed its useful life. Lastly, residual value is used in a leasing context to determine how much of an asset’s value would be left at the end of a lease based on how fast it is expected to depreciate. It is calculated as an input that helps set the amount of a lease’s periodic payments.

Return of capital

Return of capital means paying all or part an investor’s original money back to them. It is not to be confused with return on capital, which is the income made from an investment and is taxable as a gain. Return of capital is not considered income and is not a taxable event.

If an investor sells an asset for less than they bought it for, all the money received is a return of capital. If they sell it for more than they bought it for, the profit is considered a gain and is taxed.

Return on assets (ROA)

Return on assets (ROA) is a ratio comparing a company’s earnings (defined as net income) to its total assets. It shows how effectively a business uses its assets to make money, so if a company’s ROA improves over time, this means it is using its resources more efficiently to turn a profit.

This ratio, which is expressed as a percentage, varies widely between industries because some industries (like manufacturers) require major investments in assets to produce products or services, while others (like software developers) require very little. While investors may look at ROA as part of an evaluation process, it is more useful to managers than investors because it uses total assets instead of net assets, meaning it includes a company’s debts instead of just focusing on how well the company uses investments to generate income.

Return on equity (ROE)

Return on equity (ROE) is a ratio comparing a company’s earnings (expressed as net income) to its equity (its total assets minus its debts). It shows how effectively a business uses investments to make money, so if a company’s ROE improves over time, it means that it is using investor’s resources more efficiently to turn a profit.

While similar to return on assets (ROA), investors tend to favour ROE as a tool for evaluating investments because it focuses on the investment component alone rather than factoring in liabilities.

Return on invested capital (ROIC)

Return on invested capital (ROIC), also known simply as return on capital, is a ratio that shows investors the percentage they are earning on their investment. It can be compared directly to the cost of capital or weighted cost of capital to determine the health of a business model and whether it is outperforming other investment opportunities with equivalent risk.

ROIC is calculated by dividing Net Operating Income After Taxes (NOPAT) by the book value of invested capital. NOPAT adds interest expenses back in to net income, and subtracts any special, one-time losses or gains in order to provide the most precise picture of a company’s ongoing profitability.

Return on investment (ROI)

Return on investment (ROI) is a ratio that measures an investment’s profitability. It is calculated by subtracting the current value of an investment from its original cost and dividing the result by that original cost. It is usually expressed as a percentage. For example, if an investor buys $10,000 dollars of stocks and sells them for $12,000 a year later, his or her ROI is 20%.

ROI does not include a specific time frame in its equation, so it is important to use the same time period when comparing ROIs for different investments.

Return on total assets (ROTA)

Return on total assets (ROTA) is a ratio that measures how effectively a company uses its assets to make money. It is calculated by dividing Earnings Before Interest and Tax (EBIT) by total assets.

Some use ROTA interchangeably with the term ROA, but ROA is traditionally calculated using net income (which factors in taxes an interest), instead of EBIT. By using EBIT, ROTA zooms in on a business’s operating earnings and removes differences in taxation and indebtedness from the picture.

Risk assessment

In the field of investing, a risk assessment is an evaluation of the financial hazards associated with a specific investment opportunity. The exercise helps investors make decisions about what opportunities they should take. It also helps them take precautions designed to mitigate losses.

A risk assessment presents the potential of an investment or trade to earn or lose money for a trader or investor. This risk profile is then used to set a rate of return for an investment. Technical tools for assessing risk include the concepts of efficient frontier, value at risk, standard deviation, and the Sharpe ratio, as well as the capital asset pricing model.