Stock Market Terminology

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---What Is an Acquisition?

An acquisition is when one company purchases most or all of another company's shares to gain control of that company. 


Purchasing more than 50% of a target firm's stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company’s other shareholders. 


Acquisitions, which are very common in business, may occur with the target company's approval, or in spite of its disapproval. With approval, there is often a no-shop clause during the process.


---So What Is a No-Shop Clause?

A no-shop clause is a clause found in an agreement between a seller and a potential buyer that bars the seller from soliciting a purchase proposal from any other party. 


In other words, the seller cannot shop the business or asset around once a letter of intent or agreement in principle is entered into between the seller and the potential buyer. 


The letter of intent outlines one party's commitment to do business and/or execute a deal with another.


No-shop clauses, which are also called no solicitation clauses, are usually prescribed by large, high-profile companies. 


Sellers typically agree to these clauses as an act of good faith. 


Parties that engage in a no-shop clause often include an expiration date in the agreement. This means they are only in effect for a short period of time, and cannot be set indefinitely.


We mostly hear about acquisitions of large well-known companies because these huge and significant deals tend to dominate the news. 


In reality, mergers and acquisitions (M&A) occur more regularly between small- to medium-size firms than between large companies.


---What Is the Acid-Test Ratio?

The acid-test ratio uses a firm's balance sheet data as an indicator of whether it has sufficient short-term assets to cover its short-term liabilities. 


This metric is more useful in certain situations than the current ratio, also known as the working capital ratio, since it ignores assets such as inventory, which may be difficult to quickly liquidate.


---What Is Working Capital?

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable. 


Net operating working capital is a measure of a company's liquidity and refers to the difference between operating current assets and operating current liabilities. 


Working capital is a measure of a company's liquidity, operational efficiency and its short-term financial health.


If a company has substantial positive working capital, then it should have the potential to invest and grow. 


If a company's current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors, or even go bankrupt.


---What Is Adverse Selection?

Adverse selection refers generally to a situation in which sellers have information that buyers do not have, or vice versa, about some aspect of product quality. 


In other words, it is a case where asymmetric information is exploited. 


Asymmetric information, also called information failure, happens when one party to a transaction has greater material knowledge than the other party.


Typically, the more knowledgeable party is the seller. Symmetric information is when both parties have equal knowledge.


---What Is the Accounting Equation?

The accounting equation is considered to be the foundation of the double-entry accounting system. 


On a company's balance sheet, it shows that a company's total assets are equal to the sum of the company's liabilities and shareholders' equity.


Based on this double-entry system, the accounting equation ensures that the balance sheet remains “balanced,” and each entry made on the debit side should have a corresponding entry (or coverage) on the credit side.


---What Is Double Entry?

Double entry, a fundamental concept underlying present-day bookkeeping and accounting, states that every financial transaction has equal and opposite effects in at least two different accounts. 


---What Is a Liability?

A liability is something a person or company owes, usually a sum of money. 


Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. 


Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.


In general, a liability is an obligation between one party and another not yet completed or paid for. 


In the world of accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales, exchange of assets or services, or anything that would provide economic benefit at a later date. 


Current liabilities are usually considered short-term (expected to be concluded in 12 months or less) and non-current liabilities are long-term (12 months or greater).