The word principal has several meanings in business and finance. It can be a noun to describe a sum of money. It’s also an adjective that describes a person, a position in a company, or a financial arrangement. Investors, lenders, and business leaders use it often. 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.
It’s not to be confused with the term ‘principle,’ which describes a tenet or rule such as inflation or depreciation. The primary use represents the initial size of a loan or investment before interest or amortization. It can also refer to the owner of a private company or another responsible party within that firm. Dictionaries don’t adequately explain each of these examples.
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 borrowed initial sum.
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 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 was paid off.
The term is also commonly used in conjunction with investments and funds. The principal is what an investor pays into an asset before interest or earnings are accrued in the investment market. If you put $10,000 in an ISA for 5 years, at a rate of 2%, it would result in $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 apply to a chief party responsible for facilitating transactions on behalf of a 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 a business. They can be an officer, a shareholder, a board member, or even a sales professional. A company may have several principals, each with equity in the company.