Key Financial Terms Every Investor Should Know

Have you ever been confused about the difference between net and gross income? It happens to the best of us! Gross income is a common phrase we hear, for instance. But what does it really mean? What do any financial terms mean? With many phrases and words being tossed around, it is easy to be led astray in jargon. Key financial terms may already be in your vocabulary. But new terms come about, and old terms can get lost in translation. Keep up to date by reading about some key financial terms every investor in Canada should know below.

What is financial literacy and why is it important?

Financial literacy is the ability to make good financial decisions. It is the culmination of knowledge, behaviors and skills surrounding finances that allows one to make effective monetary decisions. Some of us know how to do this intuitively, and others may need to work a little harder at it (or employ a wealth manager to do it on your behalf). But reading financial articles such as this one helps! It keeps you up to date with key financial terms, phrases, and words. Ultimately, it builds your knowledge surrounding finances which will help you make more informed decisions.

Knowing the words being thrown around consistently makes them easier to use. They become less scary and more familiar. Starting with simple definitions can go a long way! This will reshape and build your relationship with financial literacy. Furthermore, if you have children at home, expanding your repertoire of key financial terms can help you pass on knowledge to better build generational wealth.

What are the basic financial terms?

Here are some basic, key financial terms to start. Brushing up and learning these terms will go a long way. They will help you better understand more complicated terms later. They will also help you have a better understanding of general finances.

Assets

An asset is something of monetary value that is owned by a person or organization. There are different types of assets. Some can be sold quickly, known as liquid assets, and some need time to find the right buyer, known as illiquid assets. Some assets are physical and tangible, while others are intangible, typically owned ideas. Examples of assets include real estate, patents and stocks.

Assets are further broken down below:

Current Assets or Liquid Assets

These account for everything that can be converted to cash, relatively quickly. Normally, the period of time is quantified in being able to convert to cash in no longer than a year. This involves sale, exchange, or withdrawal. Examples of liquid assets include bank accounts, inventory, and stocks.

Non-Current Assets or Fixed Assets

These are assets that take longer to convert to cash. Typically, it takes longer than a year to convert these assets into cash. Examples include real property, specialized machinery, and businesses.

Tangible Assets

Tangible assets are those that are physical; they can be touched and seen. In other words, tangible assets have a real world, sight, feel and use.

Intangible Assets

These hold value, even though they are not physical objects that can be touched and seen. Trademarks, patents, copyrights, and franchise agreements are all intangible assets. 

Liabilities

Liabilities are financial obligations owed to individuals and entities. These include loans, accounts payable, and any other debts. Liabilities can be further broken down into current liabilities and non-current liabilities. Generally, any liability due within a year is considered a current liability, such as a phone bill. Any liability with a longer lifespan, like a mortgage, is a non-current liability. 

Equity

Equity is the total amount of overall assets owned outright. It can also be described as net worth. When all assets are added up and all liabilities are subtracted, you are left with equity. For instance, consider an individual that has a real asset valued at $500,000 and a corresponding mortgage valued at $400,000. Their equity would be $100,000 ($500,000 – $400,000).

Depreciation/Amortization

Many assets lose value over time, this is depreciation. Assets that are subject to depreciation are often called depreciable assets. For example, an asset like a car is high value at the beginning of its life and quickly loses value — this is depreciation in action. For this reason, one cannot usually sell a car for the same amount they originally purchased it for, it is usually less.

Amortization is essentially the same as depreciation. However, it applies to intangible assets whereas depreciation applies to tangible assets.

Revenue

Revenue is income and cash flow generated from any kind of activity, may it be employment, business or investing. Income and revenue are often used interchangeably.

Expenses

Expenses are the costs incurred to generate revenue. If you primarily generate income through employment, this could include your transportation and food costs. But if you’re a business, this could be the supplies and labor to make a product.

Gross Profit

Gross profit is primarily considered within businesses. It is the amount of revenue earned when the direct cost of producing a product or service is subtracted. Gross profit does not account for all expenses. Rather, gross profit only accounts for the direct expense of the product or service being sold. For instance, a clothing company would subtract supplies, labor and shipping from revenue to arrive at gross profit. But other costs, like warehouse rent and administration, would be excluded from the calculation.

Net Profit

Net profit is how much is earned when all expenses are subtracted from total revenue. Considering net profit is essential because it’s the amount of money you take home after all costs are applied against revenue.

Related Reading: Small Business Tax Deductions in Canada

What are the financial terms for income?

Income is a broad financial term that applies to an individual or a business. Overall, the term relates to any money coming in. Here are key financial terms related to income:

Gross Income

Gross income for an individual is the total income earned before any tax deductions. It would include all sources of income. Rental income, employment income, investment income, and other sources of income are some examples. All sources of income would be added up to determine an individual’s gross income. Gross income for a company is the total revenue from all streams of income.

Net Income

Net income for the individual is the total amount earned after all taxes have been paid. Furthermore, net income for a company is the total amount earned after all expenses are deducted. Expenses include taxes, salaries, wages, and other costs.

Employment Income

Employment income is the amount an individual receives from their salary, wages, commissions, bonuses, and tips in exchange for their labor. Any income earned from an employer would constitute as employment income. This is most commonly any income earned from a full time or part time job.

Self-employment Income

Self-employment income is revenue earned through your own activities outside of a corporation. With self-employment, individuals are free to offer their services to anyone. Rates, hours, and management become a personal responsibility. Self-employment income can be an individual’s main source of income. It can also be an additional income, such as from a side hustle.

Business Income

Business income is the total income a business makes from operations. If you are self-employed and sell products and/or services, all revenue generated can also be considered business income. 

Residual Income

Residual income is the money left over after all expenses have been taken care of. It is considered extra or discretionary money. Residual income remains after all bills and debts are paid. 

Sometimes, residual income refers to cash flows that arise from an investment you previously made. For instance, if you invested in a film production three years ago and sell it to a broadcaster in the present year, that would be considered residual income.

Investment Income

Investment income is the profit earned from investments, may it be through dividends, capital gains or other cash inflows. Real estate and stocks are your typical investment income generators, but there are many ways to earn off of investments. Investment income is taxed differently than income earned. 

Other Key Financial Terms Investors Should Know

Ready to learn more key financial terms? Below is some other terminology to know!

Balance Sheet

This is a financial statement. It clearly reports company assets, liabilities, and equity at a certain point in time. Often, it is described as a “snap shot” of a company’s value on a particular date. It is a core financial document, necessary for evaluating a business’ value.

Income Statement

An income statement shows a company’s revenues, expenses, and profits for a selected period of time. It is another core financial document, necessary for evaluating a business’ performance.

Cash Flow Statement/Cash Flow

A cash flow statement breaks down the volume of cash moving in and out of a company. It helps show where money is coming from and where it is going. This help investors understand the financial positioning of a company. It also demonstrates if a company can pay down their debts while sustaining operations.

Capital Loss/Gain

When money is gained or lost through the sale of property, it is recorded as either a capital gain or a capital loss. The property sold can be real estate, stocks, bonds, art, or any collectables. Capital gains is the money earned from the sale of property minus the original cost. The expenses associated with the sale can also be removed from any capital gains. A capital loss is any reduction in value from the purchase price. Capital gains pay hefty taxes while capital losses allow for tax deductions.

Net Worth

Net worth is the total value of an individual or company. It is calculated by adding up all assets in the individual or company’s name and subtracting any associated liabilities. Another way to describe net worth is equity.

Accounts Receivable

These are funds owed to a company or individual for services or products rendered. Accounts receivable is an accrual for incoming revenue.

Accounts Payable

These are debts owed to others for goods or services you have purchased from them on account. Accounts payable is an accrual for outgoing payments.

Using Key Financial Terms to Become a Better Investor

Without baseline knowledge, it is challenging to make informed financial and investing decisions. By considering the above terms, and others you find along your journey, you can become a better, more seasoned investor. The deeper you go on your financial adventure, the more complex terms you’ll come across. Good luck on your journey and we hope this list of key financial terms helps you develop a base of financial knowledge!

Read More: Luxury Tax Canada