Loans & Amortization

Amortization is the process of paying off a balance over time with regular, equal
payments. This is most common with monthly payments on loans, but amortization
is an accounting term that can apply to other types of balances.

With loans, including home loans and auto loans, each monthly payment looks the
same, but the payment is made up of several parts that change over time. A portion
of each payment goes towards:

1. The interest costs (what your lender gets paid for the loan).
2. Reducing your loan balance (also known as paying off the loan principal).

At the beginning of the loan, interest costs are at their highest. Especially with
long-term loans, the majority of each periodic payment is an interest expense, and
you only pay off a small portion of the balance. In other words, you don’t make
much progress on debt repayment during the early years.

As time goes on, more and more of each payment goes towards your principal (and
you pay less in interest each month).

Amortized loans are designed to completely pay off the loan balance over a
certain amount of time. Your last loan payment will pay off the final amount
remaining on your debt. For example, after exactly 30 years (or 360 monthly
payments) you’ll pay off a 30-year mortgage.

Amortization in Action

Sometimes it’s helpful to see the numbers instead of reading about the process.
Scroll to the bottom of this page to see an example of an auto loan being
amortized. The table below is known as an amortization table (or
amortization schedule), and these tables help you understand how each payment
affects the loan, how much you pay in interest, and how much you owe on the loan
at any given time.
 Sample Amortization Table

The table below shows the amortization schedule for the beginning and end of an
auto loan. This is a $20,000 five-year loan charging 5% interest (with monthly
payments).

Amortization Table
Month Balance (Start) Payment Principal Interest Balance (End)
1 $ 20,000.00 $ 377.42 $ 294.09 $ 83.33 $ 19,705.91
2 $ 19,705.91 $ 377.42 $ 295.32 $ 82.11 $ 19,410.59
3 $ 19,410.59 $ 377.42 $ 296.55 $ 80.88 $ 19,114.04
4 $ 19,114.04 $ 377.42 $ 297.78 $ 79.64 $ 18,816.26
.... .... .... .... .... ....
57 $ 1,494.10 $ 377.42 $ 371.20 $ 6.23 $ 1,122.90
58 $ 1,122.90 $ 377.42 $ 372.75 $ 4.68 $ 750.16
59 $ 750.16 $ 377.42 $ 374.30 $ 3.13 $ 375.86
60 $ 375.86 $ 377.42 $ 374.29 $ 1.57 $0

Looking at amortization is extremely helpful if you want to understand how

borrowing works.

True cost of borrowing: With a detailed picture of your loan’s components, you
can clearly see how much you really pay in interest – instead of focusing on a
monthly payment. Consumers often make decisions based on an “affordable”
monthly payment, but interest costs are a better way to measure the real cost of
what you buy. Sometimes a lower monthly payment actually means you’ll pay
more in interest (if you stretch out the repayment time, for example).

Decision making: You can also decide which loan to choose when lenders offer
different terms (how much could you save with a lower interest rate?). You can
even calculate how much you’d save by paying off debt early – you’ll get to skip
all of the remaining interest charges on most loans.

To visualize amortization, picture a chart (your loan balance is the vertical X axis
and time is the horizontal Y axis) with a line going down and to the right. With
shorter-term loans, the line is more or less straight. With longer-term loans, the line
gets steeper as time goes on.
How to Amortize Loans: Calculations

There are several ways to get amortization tables (like the one above) for your
loans:

1. Build your own table by hand.

2. Use an online calculator, which will create the table for you.
3. Use spreadsheets to create amortization schedules and help you analyze
loans.

Online calculators and spreadsheets are often easiest to work with, and you can
often copy and paste the output of an online calculator into a spreadsheet if you
prefer not to build the whole model from scratch.

The monthly payment: With an amortizing loan, figuring out the payment is just
math. The payment is based on the amount of the loan, the interest rate, and how
many years the loan lasts. Those three ingredients work together to affect how
much you pay each month and how much total interest you’ll pay.

Lowering the interest rate can lower your payment, and it helps you save money.
Stretching out the loan over a longer period of time will also lower your payment,
but you’ll end up paying morein interest over the life of the loan.

To amortize a loan, use the table above as an example, and complete the following
steps:

1. Note your starting loan balance: $20,000

2. Figure out the payment (calculation shown on this page): $377.42
3. Figure out the interest charge for each period – usually monthly (calculation
shown on this page): $83.33 in the first month
4. Subtract the interest charge from your payment – the remainder is the
amount of principal you'll pay that month: $294.09 in the first month
5. Reduce the loan balance by the amount of principal you've paid: you owe
$19,705.91 after your first payment
6. Start over with the following month: $19,705.91 is the loan balance in the
second month

Types of Amortizing Loans

There are numerous types of loans available, and they don’t all work the same
way. Any installment loan is a loan that amortizes: you pay the balance down to
zero over time with level payments.
  Auto loans are often five-year (or shorter) amortized loans that you pay
down with a fixed monthly payment. In fact, some people – including buyers
and auto dealers – think of buying an auto in terms of the monthly payment
alone. Longer loans are available, but you risk being upside-down on your
loan if you stretch things out to get a lower payment (plus you’ll spend more
on interest).
 Home loans are traditionally 15-year or 30-year fixed rate mortgages. Most
people don’t keep a loan for that long – they sell the home or refinance the
loan at some point – but these loans work as if you were going to keep them
for the entire term.
 Personal loans that you get from a bank, credit union, or online lender are
generally amortized loans as well. They often have three-year terms, fixed
interest rates, and fixed monthly payments. These loans are often used for
small projects or debt consolidation.

Loans That Are Not Amortized

 Credit cards are not amortizing loans. You can borrow repeatedly on the
same card, and you get to choose how much you’ll repay each month (as
long as you meet the minimum payment – but more is better). These types of
loans are also known as revolving debt.
 Interest only loans don’t amortize either – at least not at the beginning.
During the “interest only period” you’ll only pay down the principal if you
make optional additional payments above and beyond the interest cost.
 Balloon loans require you to make a large principal payment at the end of
the loan’s life. During the early years of the loan you’ll make small
payments, but the entire loan comes due eventually. In most cases, you’ll
refinance at that point (unless you have a large sum of money on hand).
Working Capital and Cash Flows Management

Cash flow
refers to the amount of cash the company generates within a specific period of time. Cash flow is
almost never equal to net profit as companies tend to sell on credit and borrow money.
Furthermore, the cash generated through sales can be reinvested into the business or other assets,
such as real estate, stocks and bonds. Therefore, the accountant cannot simply compare the cash
at hand at the beginning and end of the accounting period to determine the cash flow. Instead, the
accountant prepares a special report, called the statement of cash flows.
 Cash flow is the net amount of cash and cash-equivalents moving into and out of a
business. Positive cash flow indicates that a company's liquid assets are increasing,
enabling it to settle debts, reinvest in its business, return money to shareholders, pay
expenses and provide a buffer against future financial challenges. Negative cash flow
indicates that a company's liquid assets are decreasing. Net cash flow is distinguished
from net income, which includes accounts receivable and other items for which payment
has not actually been received. Cash flow is used to assess the quality of a company's
income, that is, how liquid it is, which can indicate whether the company is positioned to
remain solvent.

Cash Flow Statement Often called the "statement of cash flows," the cash flow statement
indicates whether a company's income is languishing in the form of IOUs – not a sustainable
situation in the long term – or is translating into cash flow. Even very profitable companies, as
measured by their net incomes, can become insolvent if they do not have the cash and cash-
equivalents to settle short-term liabilities. If a company's profit is tied up in accounts
receivable, prepaid expenses and inventory, it may not have the liquidity to survive a downturn
in its business or a lawsuit. Cash flow determines the quality of a company's income; if net cash
flow is less than net income that could be a cause for concern.
Working capital
is the difference between current assets and current liabilities. In accounting, the term "current"
refers to assets that can be turned into cash or liabilities that are due in less than 12 months.
Because both figures are stated in the balance sheet of a corporation, the calculation of working
capital is a simple task. A large amount of working capital means that the assets of the company
are more than sufficient to cover liabilities that are soon due.

Working capital is a measure of both a company's efficiency and its short-

term financial health. Working capital is calculated as:

 Working Capital = Current Assets - Current Liabilities

The working capital ratio (Current Assets/Current Liabilities) indicates whether

a company has enough short term assets to cover its short term debt.
Anything below 1 indicates negative W/C (working capital). While anything
over 2 means that the company is not investing excess assets. Most believe
that a ratio between 1.2 and 2.0 is sufficient. Also known as "net working
capital".

Things to Remember

 If the ratio is less than one then they have negative working capital.
 A high working capital ratio isn't always a good thing, it could indicate
that they have too much inventory or they are not investing their excess
cash
Financial Planning

A financial plan is a comprehensive evaluation of an investor's current and

future financial state by using currently known variables to predict
future cash flows, asset values and withdrawal plans. Most individuals work
in conjunction with a financial planner and use current net worth, tax
liabilities, asset allocation, and future retirement and estate plans in
developing financial plans. These metrics are used along with estimates of
asset growth to determine if a person's financial goals can be met in the
future, or what steps need to be taken to ensure that they are.

 Financial plans don't have a specific template, though most licensed

professionals include knowledge and considerations of the client's
future life goals, future wealth transfer plans and future expense
levels. Extrapolated asset values determine whether the client has
sufficient funds to meet future needs. A good financial plan can alert
an investor to changes that must be made to ensure a smooth
transition through life's financial phases, such as decreasing
spending or changing asset allocation. Financial plans should also be
fluid, with occasional updates when financial changes occur.

Elements of a Financial Plan

• Financial goals: A financial plan is based on an individual's or a family's
clearly defined financial goals, including funding a college education for the
children, buying a larger home, starting a business, retiring on time or
leaving a legacy. Financial goals should be quantified and set to milestones
for tracking.

• Personal net worth statement: A snapshot of assets and liabilities serves

as a benchmark for measuring progress towards financial goals.

• Cash flow analysis: An income and spending plan determines how much
can be set aside for debt repayment, savings and investing each month.

• Retirement strategy: The plan should include a strategy for achieving

retirement independent of other financial priorities. The plan should include
a strategy for accumulating the required retirement capital and its planned
lifetime distribution.

• Comprehensive risk management plan: Identify all risk exposures and

provide the necessary coverage to protect the family and its assets against
financial loss. The risk management plan includes a full review of life and
disability insurance, personal liability coverage, property and casualty
coverage, and catastrophic coverage.
• Long-term investment plan: Include a customized asset allocation strategy
based on specific investment objectives and a risk profile. This investment
plan sets guidelines for selecting, buying and selling investments and
establishing benchmarks for performance review.

• Tax reduction strategy: Identify ways to minimize taxes on personal

income to the extent permissible by the tax code. The strategy should
include identification of tax-favored investment vehicles that can reduce
taxation of investment income.

• Estate plan: Create arrangements for the preservation and distribution of

assets with attention to minimizing settlement costs and taxes. Review and
update estate panning instruments, such as wills, inter-vivos trusts, power
of attorney, medical directives, and marital trusts.
  Loans & Amortization
 Working Capital and Cash Flows Management
 Financial Planning

Submitted by:
Ronaliza D. Gayatin

Submitted to:
Mrs. Teresa Hechanova