The word ‘principal’ has several meanings in business and finance. It can be used as a noun to describe a sum of money. It can be used as an adjective to describe a person, a position in a company, or a financial arrangement. It’s frequently used by investors, lenders and business leaders alike. If you’ve taken out a start-up loan, used a bridging loan or financed a capital investment with credit, you’re likely to be familiar with the term.
This is not to be confused with the term ‘principle’, which is used to describe a tenet or rule such as inflation or depreciation. The main use or context for the word is to describe the initial size of a loan or the size of an investment prior to interest or amortisation. However, it can also refer to the owner of a private company or another responsible party within that firm. Not all of these examples will be adequately explained in a dictionary.
Here, we’ll take a closer look at some examples of principal that you’re likely to encounter in business finance.
Examples of principal
The most commonly used definition of a principal comes from the world of borrowing. When a company or individual takes out a loan, the principal refers to the initial sum borrowed. So, if you were to take out a start-up loan for $75,000 and pay off $25,000, you would have $50,000 of the principal left to repay. However, the outstanding amount will likely be higher than this due to the addition of interest. The interest you pay is also dependent on principal. If you decided to finance a new asset with a loan for $10,000 at a rate of 5%, you would have to pay $500 in interest per year until the principal is paid off.
The term is also commonly used in conjunction with investments and funds. In the investment market, the principal is what the investor pays into an asset before any interest or earnings are accrued. If you put $10,000 in an ISA for 5 years, at a rate of 2%, you would come out with $11,000. $10,000 would be the principal, and the rest would be interest.
In bonds, the principal is the amount that the issuer of the bond is borrowing and agrees to pay back to the bondholder upon its maturity.
In a business context, a principal is a key figure in the company’s management. The term usually refers to the owner of a private company or primary decision-maker.
This may be the chief executive officer (CEO), but the title can be appointed to numerous individuals regardless of job titles. A company may also have more than one principal.
The word principal may also apply to the chief party responsible for facilitating a transaction on behalf of the company (such as a corporate merger). A principal can also appoint an agent to operate on their behalf.
Frequently asked questions about principal
Is principal the same as face value?
When referring to debt instruments, the principal refers to the face value of a bond. This is a reference to the fact that the value was printed on a paper certificate. Other synonyms include the term ‘par value’.
Does inflation affect principal?
Inflation does not affect the nominal value of the principal on a loan, bond or investment. However, it does diminish the real-term value as time goes by.
Is a principal the same as a CEO?
Not necessarily. A chief executive officer will most likely be a principal, but it is not necessary to be a CEO to be a principal in business. They can be an officer, a shareholder, a board member, or even a sales professional. A company may have several principals, each with equal equity in the company.
This article is for informational purposes only and does not constitute legal, employment, tax or professional advice. For specific advice applicable to your business, please contact a professional.