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 already 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 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.
The most commonly used definition of a principal pertains to borrowing money. When a company or individual takes out a loan, the principal refers to the initial sum that is 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 balance 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.
Other examples of principal
The term is also commonly used in conjunction with investments and funds. In the investment market, the principle 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 (e.g. a corporate merger). A principal can also appoint an agent to operate on their behalf.
Debt instruments like bonds also have a principal. In this context, the principal refers to the par value or face value of the bond– so-called because when paper bonds were originally issued, the value would be printed on the face of the bond.
The principal denotes the value of the bind before any coupon payments, accrued interest or recurring interest.
In financial transactions, a principal will be a responsible party who has the power to transact on behalf of an organisation. A principal can be an individual, but it may also be a company, a partnership, a charity or a government body.
Types of principals
For quick reference, below is a summary of the most common definitions of principal that readers are likely to encounter in their business and financial dealings.
|Borrowing||The sum of money borrowed before interest is added|
|Investment||The amount that is initially invested into an asset before interest or earnings|
|Bonds||The face or par value of a bond|
|Companies||The owner of a private company|
|Transactions||A party responsible for transacting on behalf of an organisation|
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-terms 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.
How does compound interest affect principal?
Compound interest is where you pay or receive interest on your interest rather than your principal. Therefore, the principal is not affected by compound.
What factors determine the interest that is paid on the principal?
There are a number of factors that determine the interest one will pay on their principal when borrowing money. The most prominent at the moment is the base rate that is set by the Bank of England. The credit score and history of the borrower are also significant factors, as is the length and type of loan. For instance, a personal loan will most likely have a higher rate of interest than a mortgage because it is unsecured and shorter-term.