Page 469 - Business Principles and Management

Unit 5

business note their deposits, checks that payees have cashed, ATM
Banks send customers a monthly statement showing

transactions, and bank service fees. Customers should
compare the bank statement to their own record of de-
posits and checks written and reconcile any differences.
When you take out a consumer loan, the
payments are calculated by adding the in-
terest to be paid over the term of the loan LOANS
to the principal amount and then dividing
the total by the number of months over Banks make many business and consumer loans. Before
which the money will be repaid. The result making a loan, the bank requires the prospective bor-
is your monthly payment. But what hap- rower to clearly state the purpose of the loan and pro-
pens if you pay off the loan early? You do vide financial evidence that the loan can be repaid. Most
not owe all of the interest that was origi- business loans provided by banks are for short time peri-
nally calculated. A relatively simple way to ods, often a year or less. A business may need funds to
estimate the amount of interest you should cover operating expenses at certain times, such as when
receive back is known as the “Rule of 78.” it needs new equipment or when sales are temporarily
The percentage is calculated by dividing slow. As discussed in Chapter 16, banks may offer busi-
the sum of the integer numbers (digits) nesses that are reliable customers a line of credit, which
starting from 1 up to the number of pay- gives the business a maximum amount it can borrow
ments remaining by the sum of the digits over a specified time period. The business does not bor-
starting from 1 up to the total number of row on the line of credit until the money is needed, but
payments specified in the original loan con- it does not need approval as long as the maximum loan
tract. For example, if a five-month loan is amount is not exceeded.
paid off by the end of the second month Collateral is property a borrower pledges to assure
(i.e., there are three payments remaining), repayment of a loan. If the borrower does not repay
the percentage of the interest that the the loan, the lender has the right to use the pledged
lender would rebate is (1 + 2 + 3) / (1 + 2 + property for repayment. An unsecured loan is a loan
3 + 4 + 5) = (6 / 15), or 40 percent. The that is not backed by collateral. Usually only successful,
name “Rule of 78” derives from the fact long-standing business customers can obtain unsecured
that 78 is the sum of the digits from 1 to 12 loans. For new businesses, those without strong financial
and, therefore, is the denominator in calcu- records, and most consumer loans, banks require a
lating interest rebate percentages for all secured loan. A secured loan, also called a collateral
12-payment loans. loan, is a loan backed by something of value owned by
the borrower. For example, if an entrepreneur owned a
fleet of cars for the business’s salespeople and wanted
to borrow $100,000, the fleet could be acceptable col-
lateral. In case of failure to repay the loan, the bank could sell enough of the
cars in the fleet to collect the money loaned. Businesses may pledge inventory
or accounts receivable to secure smaller loans or lines of credit. Typically a
secured loan is for an amount substantially less than the actual value of the
collateral. The bank does not want to own the collateral. If it must take own-
ership of the collateral in the event the loan is not repaid, it will want to quickly
sell the collateral and recover the money loaned.

INTEREST RATES Banks earn income when they loan money by charging interest
for the life of the loan. Interest rates are based on the supply of and demand for
money at any given time. As a result, the rate of interest can change daily, based
on general business conditions. The lowest rate is the prime rate, which is the
rate at which large banks lend large sums to the best-qualified borrowers. Small
loans and loans to less-qualified customers are made at rates higher than the
prime rate. Borrowers and lenders must establish a specific repayment plan so
that the deal benefits both parties. Borrowers may be forced into bankruptcy
and the lenders may be hurt financially when loans are not repaid. To help prevent

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