Finance Management

Finance Basics: Loan Financing (B)

What is Loan financing?  What is the Loan principal?

Posted: Apr 2009

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LOAN FINANCING

Obtaining a loan is another way of solving cash problems.

It is a form of external financing.

LOAN PRINCIPAL

The amount of money lent is known as the Loan principal.

It appears on the cash flow statement as an inflow when the loan is received and as an outflow when the loan is repaid.

It appears on the balance sheet as a liability owed to the lender.

INTEREST

The cost to the company of being able to use the loan principal is the interest.

Interest charged every period is:

•  a cost on the profit & loss statement

•  a cash outflow on the cash flow statement.

DAY SIX

Before going out to make the day's sales, JS looks in the cash drawer and realizes that there is not enough money to pay everything owed to Fast Food chain from yesterday.

Unwilling to disappoint partner, JS grits his teeth and asks the bank for a loan of $600.

Of course, the Bank wants to get something out of the deal, so interest of $20 will be charged each day for two days and the loan paid back at the end of the second day.

KEY TIPS

•  The loan principal appears as a cash inflow during the period in which it is borrowed and as a cash outflow during the period in which it is repaid.

In the meantime, it appears on the balance sheet as a source of funds,  an other liability owed to the lender.

•  Interest expense is a period cost which may be paid in cash; as such, it affects the profit & loss and the cash flow statements in the same way.  

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