Payday loans are short term loans that usually involve high interest rates. They are usually due on the forthcoming payday of the borrower. These loans are high cost loans that are riskier than other covered loans. The borrower may not be asked to provide collateral in exchange for a payday loan.
People usually take payday loans when they are short on money to get through the month till their payday. Even though these loans involve small amounts, they are very expensive, and, in some cases, the most costly loans offered.
Non-bank institutions offer these loans. Companies may offer payday loans to those people who have difficulty making ends meet. If consumers start becoming dependent on these loans to get through the month, then the company would benefit hugely.
How does a payday loan work?
Payday loans are offered online or through a physical payday lender. The laws governing payday loans might be different for different countries. The limits on how much can be borrowed or lent and how much interest can be charged are different between states as well.
Taking a payday loan comes with a cost called a finance charge. The borrower must repay the borrowed amount along with the finance charge, which depends on the amount borrowed. A period of 14 days might be offered after the borrower earns his pay check to repay the loan.
The borrower must request the amount of loan, once the request is accepted, the loan is granted. The payday loan can be rolled over to the next month in case the borrower is unable to pay. However, since the interest charged on payday loans if excessively high, the cost keeps on accumulating. The rollovers may be limited in certain areas.
Despite all the advantages offered by payday loans, it is important to note that these loans are much riskier than traditional loans and can be extremely hard to repay if they accumulate over time. Some major issues with payday loans are:
Payday loans are usually highly discouraged. They are not seen as frequently and might be more popular in the regional areas. There are various methods with which payday loans can be avoided. This includes improving upon the credit score and building a credit history to be eligible for traditional loans.
A great alternative would be to save from one’s salary and keep an emergency fund ready for the case of an emergency. If one job does not suffice the financial requirements, then having a side job for weekends can also be an effective solution.
Many people start peer-to-peer lending system that do not have very high interest rates. This can be done by pooling in a certain amount into an emergency fund, and each member taking a loan from the money collected by them. This is a local alternative that would ensure there is no exploitation of borrowers. It is always better to go for a secured loan, as usually secured loans have lower interest rates.
What is meant by Balance of Payments or BOP? Balance of Payments refers to the record of transactions maintained by a country with the rest of the world. It is a detailed list of international transactions that a country has with its trading partners. These transactions can be made by the residents, domestic businesses or by the government. In an ideal situation, the sum of all the elements of BOP should be zero. However, this is rarely witnessed as most countries do not have the exact same amount of inflow as that of outflow. The inflow and outflow from the rest of the world, can be with respect to goods, services, assets, investments, etc. Notably, a deflection from the ideal zero BOP state may not always be harmful. A surplus (positive BOP) might indicate a strong economy as it means exports are greater than imports. While, a deficit (negative BOP) might point to an increased debt on the home country. The Balance of Payments is highly reflective of the economic strength of a country. Most of the impacts of BOP are indirectly observed on various macroeconomic indicators. What are the Components of BOP? BOP comprises of two broad components, namely, Current Account and Capital Account. Sometimes the Capital Account is referred to as the Financial Account, along with a separate capital account. The Financial Account includes transactions in financial instruments and central bank reserves. While the capital account includes transactions in capital assets. A balance in inflow and outflow of all these accounts makes for a BOP equal to 0. CURRENT ACCOUNT: In technical terms, Current Account is the sum of Balance of Trade, Factor Income (net income from foreign investments) and unilateral transfers (net gifts and grants received). Put simply, current account records the transactions done in goods and services, investments and the net transfer payments or unilateral payments. Exports are maintained as credits, while imports are maintained as debits in the balance of payments. A positive current account balance means that the domestic country is a net lender, while a negative current account balance indicates that the home country is a net debtor. According to the double-entry accounting method, any entry on the export side would be adjusted with an appropriate entry on the import side. For example, for a good exported by the home country to a foreign country, the corresponding import transaction would be the inflow of foreign currency received in exchange for the good exported. CAPITAL ACCOUNT: The capital account involves all transactions relating to international asset It involves transactions made in the reserve account as well as loan payments and investment made across nations. These loans, however, do not include the future stream of interest or dividend payments as they are a part of current account. This is so because they form a part of nation’s spending or income, depending on the type of flow. A capital account is said to be in deficit when a country purchases more assets than the assets it sells to the rest of the world. An increase in assets is followed by a corresponding decrease in cash and vice versa. In some countries, the capital account is known as the financial account and has separate component called the capital account. This capital account records the transactions that do not affect the income, production or savings like international transfer of trademarks and rights, etc. What do BOP deficit and surplus mean for the home country? In layman’s language, BOP tells us whether the country is earning enough to meet its expenditure. If there is a deficit, then it can point towards the country’s growing expenses which are not sufficed by the income generated. Thus, there is a need to generate debt in order to fund the current requirements. Many a times the need to repay current debt gives rise to more debt. Therefore, an endless cycle of financing previous debt with current period loans takes place. The credit received from the rest of the world is generated either by taking a loan, which adds as a liability in the accounts or by selling off the assets currently possessed by the country. These assets can be natural resources, land, commodities, etc. A surplus on the other hand means that a country is exporting more than it is importing in all its existing BOP accounts. This can be a positive sign in most instances as it points towards stronger economic movements. A surplus can encourage the home country to invest in production of goods and services and in turn promote GDP growth. However, an export-driven growth in the long run could point to lack of sufficient demand in the home country. In such a case, the government should boost consumer spending in home country in order to become more self- reliant. What are the factors affecting BOP? BOP depends on various factors. These include: The domestic exchange rate: Exchange rate is a measure of foreign currency with respect to the domestic currency. Governments can revalue or devalue the exchange rate with the help of appropriate policies. This affects the BOP by making exports cheaper as the exchange rate falls and making imports cheaper when the exchange rate rises. The spending capacity of domestic consumers: As businesses and households are left with greater disposable income, they can spend more on imports and this can affect the BOP. Price competitiveness offered by domestic goods: For a country that is going through higher rates of inflation than its trading partner, the goods and services offered by it would be relatively more expensive. Thus, the country becomes less competitive in terms of price competitiveness. The country with lower inflation would thus have cheaper exports. In such a case, domestic consumers would prefer foreign goods and services causing increased imports and eventually a BOP deficit. Domestic policies: Trade based taxes and tariffs are a huge influencer on the BOP. Policies boosting exports are always beneficial to a country. It is important to pay attention to imports by imposing restrictions using tariffs or quotas. Apart from trade centric policies, domestic policies aimed at economic growth may cause changes in BOP. For instance, increased interest rates can promote FDI in the home country, which would affect the Current Account in BOP.
What is meant by Balance of Trade? Balance of Trade (BOT) refers to the difference between the value of exports and imports of a country for a given period. Balance of Trade is a component under the Balance of Payments, which is a balance sheet maintained by a country for all types of international transactions related to assets, goods, loans and others. Balance of Trade is added to Factor Income and Unilateral Income under the current account in BOP. If the exports of a country exceed its imports, then there exists a BOT surplus. And if the imports of a country exceed its exports, then the country is said to have a BOT deficit. A Balance of trade surplus is favourable while a deficit is unfavourable for a country. However, a deficit in the balance of trade might not always have adverse implications. Many countries continue to function with a BOT deficit. For them, a deficit simply means that they have a large dependency on imports. Larger imports are an important factor in determining any economy’s strength; however, they may not always indicate an alarming situation in the domestic economy. Are Balance of Trade and Balance of Payments same? Balance of Trade hugely impacts the Balance of Payments. However, a deficit or surplus in one does not always mean the same for the other. For instance, countries having a BOP surplus might also be observing a BOT deficit at the same time. Notably, implications of a BOP deficit/surplus and a BOT deficit/surplus are different for an economy. What are the factors affecting a country’s Balance of Trade? Domestic competitiveness: Abundance of factors of production, a good amount of resource endowment, and technological advancement in production are some of the factors that affect the competitiveness of a country. For a country that has abundant endowment of labour, the exports would be greater of those goods that are labour-intensive. Thus, the endowment of factors of production, namely, labour, capital, and land, affect the ability of a firm to compete in the international market. This follows from the Hecksher-Ohlin theory of trade. On the other hand, Ricardian model of international trade suggests that a country would export the good in which it enjoys a ‘comparative advantage’. This means that any country that has better productivity levels due to increased technology and better equipment would have more exports in that good, even if other countries are also producing that good. Inflation Rate: If a country has a higher level of prices than its trade partner, then domestic consumers would prefer imports. This could hurt the domestic producers and in turn put pressure on the Balance of Trade. Exchange Rate: If the domestic currency appreciates then foreign goods start to appear cheaper as compared to domestic goods. Thus, it could lead to exports falling and imports increasing. Demand-Supply: The demand of a good impacts the price level of that good. In case of insufficient domestic supply, the prices of a good might rise in the home country, thus making them more expensive as compared to foreign alternatives. On the contrary, in case of insufficient domestic demand, prices would decrease thus making domestic goods cheaper as compared to foreign alternatives. Foreign Exchange Reserves: Foreign exchange reserves enable the countries to increase their competitiveness so that they are at par with foreign producers, in terms of equipment, machinery and production methods. What does a deficit or a surplus in BOT mean for a country? A surplus in BOT simply indicates that the value of goods exported exceeds the value of goods imported. Thus, a surplus in BOT might indicate that an economy is going in a positive direction. However, there is no absolute conclusion that can be drawn from a positive or negative BOT. A positive BOT might provide sufficient aid to domestic operations and could provide fiscal assistance. However, it could also mean underutilisation of resources. Also, if a prolonged surplus is spent by an economy suddenly then it might be the cause of disruptions in the economy. On the other hand, a deficit can also be the consequence of a changing business cycle. It could also mean that a country has an increased demand, even if the demand is for imports. Increased demand means that consumer spending is on the rise and the economy is expanding. This is one of the most important pushes needed by growing economies to enhance their economic growth. It is not right to oversimplify the surplus as ‘good’ and deficit as ‘bad’ for the economy, as it is important to note the cause of either of those circumstances. Moreover, domestic policies, productivity levels, trade laws and various other factors are important determinants of how strong the economy of a country is compared to that of its trading partners.
What is capital? Capital refers to the financial assets held by a firm and/or funds outsourced from other forms of financing. Capital can have multiple meanings; however, this is the definition used in finance. In a more general sense, capital is understood as anything that generates more value. Capital can be defined differently based on the usage of the term. In finance, capital refers to the equity, debt, investments and working capital held by firms. In economics, capital refers to human capital which is the capacity of individuals in an economy to contribute towards economic production. Natural resources may sometimes also be referred to as capital; however, this usage of the term is excluded from both economics and finance. Is money a form of capital? Money cannot be strictly defined as capital because money itself is an instrument to purchase goods and services which end up becoming the capital. For instance, the investments made in financial instruments by firms are a form of financial capital. Thus, any money held by a firm may not precisely be termed as capital; however, once it is invested in financing activities, it becomes a form of capital. What are the components of financial capital? Financial capital includes the following: Debt: The most common form of capital used in business is debt. Firms may take borrowings from banks or from family members to finance their operations in the beginning. In case of borrowings from the banks or any monetary institutions, firms must repay the principle with interest. Debt is an easy method of financing business activities; however, the interest associated with it might make it expensive for some. If the business fails, the borrower must repay the debt. The advantage of taking a loan is that the profits need not be shared. Equity Capital: The type of capital comes from investors who put their money in the initial stages of the company. This is done in exchange for a part of the profits that must be shared with the investors in the future. Businesses may initially fund their processes themselves; thus, they own 100% equity and would earn all the profits. However, angel investors or venture capitalists may sometimes invest too. In those cases, a proportion of the profits goes to these investors. This may be disadvantageous in some cases, where investors end up taking a large stake in the company in exchange for initial capital provided by them. Businesses that are at an early stage might benefit from the initial investment; however, their profits in future are decreased by a large percentage. Working capital: This includes the most liquid assets that a company possesses. These are the assets that can be easily converted to cash. Working capital is maintained to fulfil daily transactions and is calculated on a regular basis. It can be obtained by subtracting current liabilities from current assets, or by adding accounts receivables and inventory, and subtracting accounts payable from both. To summarise, working capital is derived as: How is financial capital different from economic capital? Financial and economic capital are both utilised in a business. However, financial capital is a much broader term. Economic capital, on the other hand, refers to the estimated amount of money required to bring a firm out of losses. It can be interpreted as the amount of money required to repay the outstanding liabilities. The concept of economic capital was introduced to manage risk. This is used to analyse the amount of funds that would be required to compensate any losses in the future. There are various models used to determine the capital needed to manage risks. Economic capital may sometimes also include human capital, or the tools used to produce goods. In economics, capital may also refer to one of the factors of production used in producing goods and services in an economy. Out of the two, financial capital is the most prime version utilised by firms and is commonly seen across businesses. Therefore, if used alone, the word capital most commonly refers to financial capital only. What is the cost of capital? There is a cost associated with acquiring capital. Since capital includes loans and borrowings to finance the business, the cost of capital depends upon the coupon, interest rates, and yield to maturity of the debt. The Capital Asset Pricing Model or CAPM is used to calculate the cost of equity. CAPM uses the volatility of the returns as a measure of calculating how much the investment should cost in a year. On the other hand, cost of debt is equal to the interest paid on loans. Cost of equity would always be higher than the cost of debt. This is so because the cost of equity is riskier and more vulnerable to fluctuations. Why is capital important for businesses? Capital allows businesses to expand and grow in wealth. It boosts productivity in the economy and provides valuable goods and services necessary to sustain. Businesses realise the importance of maintaining capital and they use various methods to analyse on how to maintain it.
What is Capital Investment? Capital Investment basically refers to the funds invested by a company towards acquisitions or enhancement of its business. This capital can be recovered through earnings made by the company over the years. The term ‘capital investment’ is also called as ‘capital budgeting’. Without capital investment, a business may face a difficult time getting off the ground. There are two ways to understand capital investment. First, capital investment can be made in the form of physical assets like property, plant and equipment (PP&E), furniture. It also helps to enhance the business performance. Second, the capital investment can also be made in loan form. In this case, investors get their returns by way of repayment of loan or profits from the business. Who are the sources of Capital Investments? Generally, capital investment is sought by new companies or startups in any sector. Investors in these businesses can be angel investors, centre capitalists, financial institutions, etc. As investors mostly invest in a company which has future potentials, they do their due diligence before making any investment. Therefore, the companies must use the money for development of their business to give good returns to the investors in the long term. Similarly, when a company goes for an IPO to list on stock exchanges, the large amount of money pooled in by the investors is also known as capital investment. How Capital investment is important for Economy? Investment always plays an important role in boosting a country's economy. It is a component of AD (Aggregate Demand). Therefore, if investment increases, it will increase AD and eventually help in economy growth in the short term. For example, when a company makes capital investments, it means they are sure about the future growth of businesses. And when a business grows, it will call for more employment. Therefore, if there is a reduction in capital investment, it will increase the risk of recessions. What are the types of Capital Investment? Financial capital Investment Generally, a large amount of money is invested in a business. It can be invested before or during the operations especially when a business is completely relying on the capital to continue. The sources of capital investment can also be venture capital firms or angel investors who gain attention in some of the companies of their interest which have winning ideas. Other traditional source of capital are bank loans. Physical Capital Investment Physical capital investment includes the investment done in the form of buying long-term assets like land, machinery, furniture etc to increase or continue growth of the company. In both the cases, purchase decision is taken by the management. What is the aim of Capital Investment? Capital investment is used to improve the growth of a company. A company which has been performing well, and can produce and generate more revenue, can go for further capital investment. This is how capital investment helps an economy, employees, and the management to grow in the future and add shareholder value. Economy: An additional fund (capital investment) provides financial boost to a company’s business. Obviously, it helps to increase production and ultimately helps in improving economy as capital serves to improve the GDP and per capital income. Employment: Increasing production in a company will lead to an increase in the number of employees. Therefore, it will generate employment opportunities. Wealth Generation: When a company grows, it reports better revenue and profit in its financial books. This ensures higher income for employees and management as well as potentially for future investors and current shareholders of the company. Market competition: When there is a huge competition in market regarding the same product and services of a company, then it becomes necessary for that firm to make improvements and try to remain unique to maintain its reputation in the market. Therefore, a company needs capital to continue to survive in the competitive environment. Wealth Creation: If a company runs well and generates good profits, the owners may take a hefty share of the earnings that would not have been possible in regular jobs. For the next round of fundraising, if a startup performs really well, investors calculate the ROI (return on investment) and IRR to invest more. That turns out to be a win-win situation for everyone including financial investors, employees, founders, and others. What are the disadvantages of Capital Investment? It is universally accepted that everything has few pros as well as cons. We have already discussed the benefits of capital investment, let’s now talk about few disadvantages of the same. High stress: Raising funds for a company is a highly stressful time for the management, owing to the pressure of generating revenue and turning profitable. High Risk: Not all businesses manage to grow and generate profits. There is always a risk of failure as capital investment is not the only factor that can ensure a company’s ability to thrive. There can be other factors that can heighten the risk of failure. High Visibility: When a bank provides loan or an investor invests in a company, it adds to the business’s visibility, grabbing the attention of more and more investors. . Failure: There is always a possibility for businesses to fail, as they are fraught with a plethora of risks. Any wrong step or small mistake can drive business to loss or put the entrepreneur at stake. Failures are not necessarily caused due to the mistakes of owner, sometimes business may also fail due to bad market circumstances.