3. Personal Saving & Borrowing
+ Business Finance & Accounting

Part 1: Personal Saving and Borrowing

Savings Vehicles

• High-Yield Savings Account (HYSA): FDIC-insured bank account paying higher interest than a standard savings account. Fully liquid — funds accessible at any time. Appropriate for emergency funds and short-term savings goals.
• Certificate of Deposit (CD): Bank deposit for a fixed term (3 months to 5 years) at a guaranteed interest rate. Higher interest than HYSA but funds are locked — early withdrawal incurs a penalty. Appropriate when you know you will not need the funds before maturity.
• Opportunity cost of saving: Choosing to save money instead of spending it means forgoing the consumption value of that spending. Choosing to spend means forgoing future interest earnings. Both decisions have an opportunity cost.

Compound Interest

Compound interest earns interest on previously earned interest, causing savings to grow exponentially over time.

$$A = P\!\left(1 + \frac{r}{n}\right)^{nt}$$

where $P$ = principal, $r$ = annual interest rate (decimal), $n$ = number of compounding periods per year, $t$ = years, and $A$ = final amount.

Example: $1,000 at 5% annual rate, compounded monthly, for 3 years:

$$A = 1000\!\left(1 + \frac{0.05}{12}\right)^{12 \times 3} = 1000 \times (1.004167)^{36} \approx \$1{,}161.62$$

Simple interest (for comparison): $A = P(1 + rt) = 1000(1 + 0.05 \times 3) = \$1{,}150.00$. The difference ($11.62) represents the compounding effect over 3 years — small here, but significant over decades.

Credit and Debt

Credit score (300–850): A numerical representation of creditworthiness based on payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). Higher scores unlock lower interest rates on loans.

Types of credit:

Type	Characteristics	Typical APR range
Credit card	Revolving credit; pay minimum or in full each month; high APR if balance carried	18–29%
Personal loan	Fixed term, fixed payment, typically unsecured	8–20%
Auto loan	Secured by the vehicle; lower rate than unsecured	5–12%
Mortgage	Secured by the property; longest term (15–30 years); lowest rate of consumer credit	4–8%

Debt-to-income (DTI) ratio: Monthly debt payments ÷ gross monthly income. Lenders use DTI to assess repayment capacity. A DTI above 43% typically disqualifies a borrower for most mortgages.

Debt management strategies: The avalanche method pays minimum on all debts and directs extra funds to the highest-interest debt first (mathematically optimal — minimizes total interest paid). The snowball method pays minimum on all debts and directs extra funds to the smallest balance first (psychologically motivating — faster early wins).

Part 2: Business Finance and Accounting

Startup vs. Operating Costs

• Startup costs: One-time costs to get the business running — equipment purchase, legal fees, initial inventory, website build, licenses. Incurred before revenue begins.
• Operating costs: Ongoing costs to run the business — rent, salaries, utilities, raw materials, marketing. Recurring expenses that appear on the income statement.
• Fixed costs: Do not change with production volume (rent, insurance, salaried employees).
• Variable costs: Change directly with production volume (raw materials, hourly labor, shipping).

Sources of Capital: Equity vs. Debt Financing

Feature	Equity financing	Debt financing
Source	Investors (angel investors, venture capital, selling shares)	Lenders (banks, bonds, SBA loans)
Repayment	No fixed repayment obligation — investors share in future profits	Fixed repayment schedule with interest
Ownership impact	Dilutes owner's ownership percentage	No dilution — owner retains full ownership
Risk to business	Lower — no default risk if business underperforms	Higher — missed payments can trigger default
Investor/lender focus	Growth potential, market size, team quality	Cash flow, collateral, credit history, DTI

The Three Financial Statements

Exam trap — know which statement answers which question:

• Is the business profitable? → Income Statement
• What does the business own and owe right now? → Balance Sheet
• Does the business have enough cash to pay its bills? → Cash Flow Statement

Income Statement

Reports revenue, expenses, and profit over a period of time (month, quarter, year).

$$\text{Gross Profit} = \text{Revenue} - \text{COGS}$$

$$\text{Operating Income} = \text{Gross Profit} - \text{Operating Expenses}$$

$$\text{Net Income} = \text{Operating Income} - \text{Taxes} - \text{Interest}$$

COGS (Cost of Goods Sold) = direct costs of producing the goods sold (raw materials, direct labor). Operating expenses = indirect business costs (rent, marketing, administrative salaries).

Balance Sheet

Reports what the business owns and owes at a single point in time. The fundamental accounting equation:

$$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$$

• Assets: What the business owns. Current assets (cash, accounts receivable, inventory — converted to cash within 1 year) + Long-term assets (equipment, real estate, intangibles).
• Liabilities: What the business owes. Current liabilities (accounts payable, short-term loans — due within 1 year) + Long-term liabilities (mortgages, long-term debt).
• Owner's Equity: The residual claim after liabilities are subtracted from assets — what owners would receive if the business were liquidated and all debts paid. Net Worth = Assets − Liabilities.

Cash Flow Statement

Reports actual cash inflows and outflows over a period, organized into three activities:

• Operating activities: Cash from the core business — customer payments received, supplier payments made, employee salaries paid. This is the most important indicator of business health.
• Investing activities: Cash from buying or selling long-term assets — purchasing equipment, acquiring another business, selling property.
• Financing activities: Cash from borrowing or repaying debt, issuing or buying back shares, paying dividends.

Key insight: A business can be profitable (positive net income on the income statement) while simultaneously running out of cash (negative operating cash flow) — for example, if customers are slow to pay their invoices. The cash flow statement reveals this gap that the income statement hides.

Key Financial Ratios

Ratio	Formula	What it measures
Profit margin	Net Income ÷ Revenue	What percentage of each revenue dollar becomes profit
Current ratio	Current Assets ÷ Current Liabilities	Ability to pay short-term obligations (above 1.0 = positive)
Debt-to-equity	Total Liabilities ÷ Owner's Equity	Financial leverage; how much debt vs. owner investment funds the business

GAAP and Financial Ethics

Generally Accepted Accounting Principles (GAAP) are standardized rules for financial reporting that ensure consistency, comparability, and reliability across businesses. Key principles include:

• Revenue recognition: Revenue is recorded when earned (goods delivered/services rendered), not when cash is received.
• Matching principle: Expenses are recorded in the same period as the revenue they helped generate.
• Consistency: Same accounting methods used year-to-year; changes must be disclosed.

Fraudulent financial reporting — inflating revenue, hiding liabilities, misclassifying expenses — misrepresents the business's true financial position to investors and lenders, causing market harm and triggering regulatory consequences (SEC enforcement, criminal prosecution).

Worked Practice: Financial Statement Analysis