Borrowing Basics

 

Rules for borrowing

Sometimes in 2014 I had read a report by Australian Securities and Investment Commission. It said that one of the main reasons businesses failed was because of poor financial control. That made me curious to do a research. I analyzed hundreds of financial statements of businesses heading towards bankruptcy, and of businesses making low profits. Very soon a pattern emerged. I compiled my research and came up with two common Finance mistakes made in Business.

Let me again explain in layman’s terms. Let us suppose there is a person called Tom and he is walking up the street. Suddenly he sees $1000 lying on the street. Tom takes that $1000 and puts it in his pocket. That $1000 has not cost Tom anything.

Now let us suppose there is a person called Nick, and Nick needs $1000. He approaches Tom and asks if he could borrow $1000 dollars from him. He is ready to pay 10% interest on it. Tom knows that if he keeps the $1000 in his pocket, even after one year it will still be $1000. On the other hand if he accepts the offer of giving the $1000 at the rate of 10%, after one year he would have $1100. @11100 is $1000 plus 10% interest earned by it.

Let us suppose there is another person called Harry. Even Harry needs @1000. Now harry approaches nick and asks if he could borrow $1000 from him. He is ready to pay 5% interest. Do you think Nick would say yes? Definitely he will say no. Now Harry says that he was willing to pay 19% interest. Nick would definitely say No simply because it is costing him 10%. Nick may say yes if Harry offers to pay him 15 – 20% interest.

More to come in the next post….

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