In the world of finance, there are many essential concepts and principles that students or business owners should understand. This article will explore 9 key learnings from Finance 101.
1. The Foundation of Finance: Cost of Capital
The cost of Capital, commonly known as interest, is crucial because it represents the cost incurred when borrowing money for investment or use. For example, if the loan interest rate is approximately 18% per year, borrowing 100,000 SGD would result in an annual interest payment of 18,000 SGD
2. 100 SGD Today is Not the Same as 100 SGD in the Future
Due to the principle of interest, 100 SGD today will not be equal to 100 SGD in the future. This is a fundamental concept in finance. For instance, if you deposit 100 SGD in Krung Thai Bank at an interest rate of 3% per year, you will have 103 SGD in one year. However, if you borrow 100 SGD, you must repay it with interest according to the agreed rate.
3. Interest and Compound Interest
Interest can be daunting when Compound Interest (interest on interest) occurs. For example, if you have a principal amount of 100 SGD at an interest rate of 5% for 50 years, the principal will grow to approximately 1,146.74 SGD. This can be calculated using the formula:
[ FV = PV(1 + r)^t ]
Example calculation:
100(1 + 0.05)^50 = 1,146.74
Even a modest interest rate over a long period can significantly multiply the principal.
4. Leverage: Borrowing for Investment
While using cash for investment eliminates interest payments, borrowing can allow for more significant investments, particularly in high-growth assets such as stocks or real estate. For example, if Company A’s stock has an average annual return of 8%, which is higher than a loan interest rate of 5%, borrowing to invest can yield a net positive return.
5. Interest as a Tax-Deductible Expense
Interest paid on borrowed funds can be a tax-deductible expense. For instance, if a company has revenue of 1,000,000 SGD and interest expenses of 50,000 SGD, the taxable income can be reduced as follows:
Taxable Income : 1,000,000 – 50,000 = 950,000 SGD
6. Cash Flow Management
If a company lacks sufficient cash flow, borrowing becomes necessary to keep the business running. For example, a company may need to borrow from a bank to purchase raw materials before receiving revenue from sales. If the bank provides a revolving credit line of 500,000 SGD, the company can use this credit to cover expenses.
7. Delayed Payments from Customers
Sometimes, customers delay payments for 60 or 90 days, requiring the company to have cash reserves for operational liquidity. For example, a company selling goods on 60-day credit terms must wait 60 days to receive payment.
Data from industry surveys indicate that companies in industry X experience an average customer payment delay of 75 days, exceeding the credit terms set.
8. Supplier Credit Management
If a company purchases on credit from suppliers, it can manage cash flow more efficiently. However, if payments must be made in cash, the company must find ways to cover this gap. For instance, if a company must pay for raw materials within 30 days but receives customer payments in 60 days, it must manage cash flow during this shortfall.
Industry Y data shows that companies pay suppliers within an average of 45 days.
9. Risk Management
Risk management is crucial, as customers may fail to pay or suppliers may not deliver on time. Companies must have contingency plans and diversify risks to mitigate potential problems. Examples include insuring assets or negotiating with multiple suppliers to avoid reliance on a single source.
Data from surveys show that companies in Industry Z have customers who do not pay, averaging 5% of total sales.
Using Data to Support Each Point
Using data to analyze and make financial decisions is very important. We can use data to:
- Analyze Interest Rates: Compare interest rates from different banks to find the best offer.
- Calculate the Future Value of Investments: Use interest rate data to calculate the future value of investments.
- Manage Cash Flow: Use data to track cash inflows and outflows to manage cash flow efficiently.
- Analyze Risks: Use data to analyze risks from customers and suppliers to plan for contingencies.
Calculate Taxes: Use data to calculate the taxes payable after deducting interest expenses.
Using data in analysis and decision-making is a tool that helps manage finances efficiently and reduce risks significantly.