Finance glossary

Plain-English definitions and formulas for the terms you'll hear in investment banking and private equity, from DCF and LBO to UFCF and WACC.

A

Accretion / dilution

Whether an acquisition increases (accretive) or decreases (dilutive) the buyer's earnings per share. A core output of a merger model for public acquirers.

Accretion / dilution % = pro forma EPS ÷ standalone EPS − 1

Accrued expenses

Costs a company has incurred but not yet paid, such as wages or interest owed at period-end. A current liability; an increase provides cash.

Amortization

Spreading the cost of an intangible asset, like acquired customer relationships or capitalized software, over its useful life. Also used for scheduled repayments of loan principal (“mandatory amortization”).

B

Balance sheet

A snapshot of what a company owns (assets) and owes (liabilities), and the owners' stake (equity), at a point in time.

Assets = Liabilities + Shareholders' equity

Beta (β)

How much a stock tends to move relative to the overall market. A beta of 1.2 means it typically moves 20% more than the market. Used in CAPM to estimate the cost of equity.

Bullet repayment

Debt repaid in one lump sum at maturity, with no principal paid before then. Common for bonds and subordinated notes.

Buy side

Firms that invest capital, such as private equity, hedge funds and asset managers. Contrast with the sell side, which advises and executes transactions.

C

CAPM (capital asset pricing model)

The standard way to estimate the cost of equity: a risk-free return plus a premium for the stock's market risk.

Cost of equity = Risk-free rate + β × Equity risk premium

Capex (capital expenditures)

Cash spent on long-lived assets like equipment, buildings and vehicles. Shown in cash flow from investing; increases PP&E. Often split into maintenance and growth capex.

Template: IronLeaf Fitness PP&E schedule

Cash flow statement

Shows how cash moved during a period, in three sections: operating, investing and financing activities. It reconciles net income to the change in cash.

Cash sweep

Using excess free cash flow, after required payments, to repay debt early. A key driver of deleveraging in an LBO.

Optional repayment = MIN(debt remaining, cash available × sweep %)

CIM (confidential information memorandum)

A detailed marketing document a sell-side bank prepares about a company for sale, shared with potential buyers after they sign an NDA. Preceded by a short anonymous “teaser.”

Comparable companies (comps, trading comps)

A relative valuation method that values a company using the trading multiples, like EV/EBITDA or P/E, of similar public companies.

Covenants

Rules in a loan agreement the borrower must follow, such as keeping leverage below a set level (maintenance covenants) or limits on new debt and dividends (incurrence covenants).

D

D&A (depreciation and amortization)

The combined non-cash charge for using up tangible and intangible assets. Added back to EBIT to get EBITDA, and to net income in the cash flow statement.

Data room

A secure online repository of documents (contracts, financials, legal records) that buyers review during due diligence.

DCF (discounted cash flow)

An intrinsic valuation method. Project a company's unlevered free cash flows, estimate a terminal value, and discount both to today at the WACC. The result is enterprise value.

Enterprise value = Σ UFCF_t ÷ (1 + WACC)^t + TV ÷ (1 + WACC)^N

Debt schedule

The part of a model that tracks each debt tranche's opening balance, interest, repayments and closing balance each period.

Practice: Debt schedule and cash sweep lesson

Depreciation

Spreading the cost of a tangible asset over its useful life. A non-cash expense that reduces taxable income, creating a tax shield.

Straight-line depreciation = (Cost − Salvage value) ÷ Useful life

Dividend recapitalization

When a company borrows new debt to pay a dividend to its owners, often a PE sponsor returning cash before exit. Usually raises IRR.

E

EBIT (earnings before interest and taxes)

Operating profit: revenue minus operating costs, including D&A. Independent of how the company is financed.

EBIT = Revenue − COGS − Operating expenses − D&A

EBITDA (earnings before interest, taxes, depreciation and amortization)

A widely used proxy for operating cash flow, and the basis for most valuation multiples and debt sizing in LBOs. It ignores capex and working capital, so it overstates cash for capital-heavy businesses.

EBITDA = EBIT + D&A

Enterprise value (EV)

The value of a company's core operations to all capital providers, debt and equity alike. What a buyer effectively pays for the business.

EV = Equity value + Debt + Preferred stock + Minority interest − Cash

Equity value

The value belonging to shareholders. For a public company, share price × diluted shares outstanding.

Equity value = Enterprise value − Net debt (and other non-equity claims)

Exit multiple

The valuation multiple, usually EV/EBITDA, assumed when a sponsor sells a business, or used to estimate terminal value in a DCF.

F

FCFE (free cash flow to equity, levered free cash flow)

Cash available to shareholders after operating needs, reinvestment and payments to lenders. Discounted at the cost of equity to get equity value directly.

FCFE = Net income + D&A − Capex − ΔNWC + Net borrowing

FCFF (free cash flow to the firm)

Cash generated by the business that's available to all capital providers, before any interest or debt payments. Effectively the same thing as unlevered free cash flow (UFCF). Discounted at the WACC in a DCF.

FCFF = EBIT × (1 − tax rate) + D&A − Capex − ΔNWC

Free cash flow (FCF)

Cash left after running the business and investing in it. Definitions vary, so always check whether someone means unlevered (before interest) or levered (after interest).

Simple FCF = Cash flow from operations − Capex

G

Growth capex

Capital spending to expand capacity, such as new stores, factories or locations. Contrast with maintenance capex, which keeps existing assets running.

Gordon growth method (perpetuity growth)

A way to calculate terminal value by assuming cash flows grow at a constant rate forever. The growth rate should be modest, typically around long-run inflation or GDP growth.

TV = UFCF_N × (1 + g) ÷ (WACC − g)

I

Income statement

Shows revenue, expenses and profit over a period, ending in net income. Also called the profit and loss statement (P&L).

Template: Bean There Coffee Co. income statement

Interest tax shield

The tax saved because interest is deductible. One reason leverage can increase equity returns.

Interest tax shield = Interest expense × Tax rate

IRR (internal rate of return)

The annual return that makes the net present value of all cash flows zero. The headline return metric in private equity.

With one entry and one exit: IRR = MOIC^{(1 ÷ years)} − 1

L

LBO (leveraged buyout)

An acquisition, usually by a private equity firm, funded with a large amount of debt and a smaller amount of equity. The company's cash flow repays the debt, and the sponsor earns a return when it sells.

Read more: Walk me through an LBO · Template: Saltmarsh Heating & Air LBO

Leverage (leverage ratio)

How much debt a company carries relative to its earnings. Lenders and sponsors usually quote it as a multiple of EBITDA.

Leverage = Total debt ÷ EBITDA (net leverage uses net debt)

LTM (last twelve months)

Financial results for the most recent 12-month period, also called TTM (trailing twelve months). Entry multiples in LBOs are usually based on LTM EBITDA.

M

M&A (mergers and acquisitions)

Companies combining or buying one another. Investment banks advise either the seller (sell-side) or the buyer (buy-side).

Maintenance capex

Capital spending required just to keep existing assets working, such as replacing worn equipment.

Mandatory amortization

Scheduled principal repayments a borrower must make on a loan, often a fixed percentage of the original term loan each year.

MOIC (multiple on invested capital)

How many times an investor multiplied their money. Ignores time, so it's read alongside IRR.

MOIC = Total equity returned ÷ Total equity invested

Multiple expansion

Selling a company at a higher valuation multiple than you bought it for. One of the three LBO return drivers, alongside EBITDA growth and debt paydown.

Practice: Value creation bridge lesson

N

Net debt

Total debt minus cash and cash equivalents. The bridge between enterprise value and equity value.

Net debt = Total debt − Cash

NOPAT (net operating profit after tax)

Operating profit after taxes, as if the company had no debt. The starting point for unlevered free cash flow.

NOPAT = EBIT × (1 − Tax rate)

NPV (net present value)

The present value of future cash flows minus the upfront investment. A positive NPV means the investment earns more than the discount rate.

NPV = Σ CF_t ÷ (1 + r)^t − Initial investment

NWC (net working capital)

The cash tied up in day-to-day operations. An increase in NWC uses cash; a decrease releases it. Models usually exclude cash and debt from this calculation.

NWC = (Accounts receivable + Inventory + other operating current assets) − (Accounts payable + Accrued expenses + other operating current liabilities)

P

Paper LBO

A simplified LBO solved with pen and paper in an interview, usually in 10 to 15 minutes, to test whether you understand the mechanics.

P/E ratio (price-to-earnings)

Share price divided by earnings per share. An equity-value multiple, so it's affected by capital structure, unlike EV/EBITDA.

P/E = Share price ÷ EPS = Equity value ÷ Net income

PIK (payment-in-kind)

Interest paid by adding to the loan balance instead of in cash. Preserves cash but makes the debt grow over time.

PP&E (property, plant and equipment)

Long-lived physical assets on the balance sheet, shown net of accumulated depreciation.

Ending PP&E = Beginning PP&E + Capex − Depreciation

Precedent transactions

A relative valuation method based on multiples paid in past acquisitions of similar companies. Often higher than trading comps because acquirers pay a control premium.

R

Revolver (revolving credit facility)

A flexible line of credit a company can draw, repay and draw again, like a corporate credit card. Used for short-term liquidity needs.

Retained earnings

Cumulative net income a company has kept rather than paid out as dividends. Part of shareholders' equity.

Ending RE = Beginning RE + Net income − Dividends

S

Sell side

Firms that advise on deals, raise capital and make markets, such as investment banks, brokers and equity research. Also refers to representing the seller in an M&A deal.

Senior debt

Debt that gets repaid first if a company runs into trouble, often secured by its assets. Cheaper than subordinated debt because it's less risky.

Sensitivity table

A grid that shows how an output, like IRR or share price, changes as two inputs change, like entry and exit multiples.

Practice: Sensitivity tables lesson

Sources and uses

A table showing where a deal's money comes from (debt, sponsor equity) and where it goes (purchase price, fees, refinancing). The two sides must be equal.

Practice: Sources and uses lesson

Subordinated debt (junior debt, mezzanine)

Debt repaid after senior debt in a bankruptcy. Carries a higher interest rate to compensate for the extra risk.

Synergies

Cost savings or extra revenue expected from combining two companies. Strategic acquirers can often pay more than financial sponsors because of them.

T

Terminal value (TV)

The value of all cash flows beyond the explicit forecast period in a DCF, often the largest part of the valuation. Calculated with the perpetuity growth (Gordon growth) method or an exit multiple.

Exit multiple method: TV = Final-year EBITDA × EV/EBITDA multiple

Term loan

A loan with a set maturity and repayment schedule, typically senior and secured. Term Loan A usually amortizes faster; Term Loan B has small amortization and a larger repayment at maturity.

U

UFCF (unlevered free cash flow)

Cash generated by the business before any payments to lenders, as if the company had no debt. Because it's “capital-structure neutral,” it's the cash flow used in a DCF and discounted at the WACC. Interchangeable with FCFF in most contexts.

UFCF = EBIT × (1 − Tax rate) + D&A − Capex − ΔNWC

Example: EBIT of $120m at a 25% tax rate gives NOPAT of $90m. Add back $15m of D&A, subtract $25m of capex and an $8m increase in NWC: UFCF = $90m + $15m − $25m − $8m = $72m.

Further reading: Wall Street Prep: Unlevered Free Cash Flow (UFCF) · See also: FCFE, DCF

Unlevered vs. levered

“Unlevered” means before the effects of debt (interest and repayments); “levered” means after. Unlevered metrics compare businesses regardless of capital structure; levered metrics show what's left for equity holders.

V

Value creation bridge

A breakdown of a sponsor's equity gain into EBITDA growth, multiple expansion and debt paydown (less fees).