The financial world can sound very complicated if you don’t understand the terms. In our super simple guide below, we explain some of the basic financial terms that will help you prepare for your better financial future. It will increase your financial literacy and possibly help you to grow your wealth as well.
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80-20 Rule
The 80-20 rule is also called the Pareto principle. Joseph M. Juran (a management consultant) suggested the principle and named it as such after the economist Vilfredo Pareto who noted the 80/20 connection. This principle specifically highlights cause and effect scenarios pertaining to the distribution of wealth amongst a population.
For instance, it claims that in particular closed environments (like the economy of a country) 20% of the population owns 80% of the wealth. Thus meaning the remaining 20% of the wealth is owned by 80% of the population. This rule could also be applied to the income and sales of a business. Some businesses get 80% of their revenue from 20% of their customers.
Acid-Test Rule
The acid-test rule is also called the quick ratio. It measures a business’ ability to meet its short term liabilities. This helps to determine whether a business can keep a positive cashflow. An acid test ratio of 1 or more is good. Anything less than one means like 0.5 is bad, because it indicates that a business can only cover half of it short term liabilities if it had to use current assets like cash, marketable securities, and money receivable from debtors.
Acid test ratio = (Current assets – Inventory) / Current liabilities
Let’s say a company has R1,000 in current assets, R200 of inventory, and they need to repay R500 of current liabilities. This company has an acid test ratio of 1.6 which means it is able to cover its short term credit repayments with ease.
Asset
An asset is something with value. It’s worth something. You can sell it for cash or you can keep it to capitalize on its growth potential (possible increase in value). Assets may require a bit of maintenance (costs to ensure its upkeep), but assets cause income or growth in wealth.
Your personal car may have value but it doesn’t supply income and therefore is mostly not classified as an asset. It’s a piece of equipment, a means to an end, something that gets you from A to B. However, an antique vehicle you bought in the hope of reselling at a higher value is an asset.
Annuity
A type of investment that requires monthly deposits for a set number of months (or years). On a set date an annuity starts paying a monthly amount into your bank account. You stop making deposits into an annuity when it reaches that date and then capitalize on the monthly payouts. An annuity reaches a maturity date when the owner (you) reach a specific age (usually between 85 – 100) whereupon it cash’s out completely in the agreed manner.
The payouts are determined by an APR (Annual Percentage Rate – see below) of the total amount you’ve saved over the years of deposits made. The annuity pays out to its beneficiary until the investment is liquidated, sold, or closed down due to stipulations in the annuity agreement (the contract with the company who offers the annuity).
Annual Percentage Rate (APR)
A yearly interest rate charged on either an investment or form of credit. It determines how fast interest accumulates on the investment or debt.
A R1,000 investment with an APR of 5% generates R50 of interest in its first year. The following year the total investment is worth R1050 and the 5% APR generates R52.50 of interest. The investment total increases to R1102.50.
ATM
An ATM (Automated Teller Machine) offers specific services to bank customers. Most people use ATMs to withdraw money from their accounts.
Most banks in South Africa have their own dedicated ATM’s and charge their customers a small fee for its usage. Expect to more expensive fees if you use an ATM from another bank.
Bankruptcy
A legal procedure that involves a person or business who can’t repay their debt anymore. Most probably because their debt has exceeded the value of their assets and they have lost the ability to make sufficient income. The said party files a petition for their wealth to be measured, evaluated, and eventually used to repay portions of their creditors and debt.
A business that owes R15,000 per month in debt repayments but only earns R10,000 per month may possibly have to file for bankruptcy. Let’s say their debt totals to R1,000,000. But their business is only worth R800,000. When they file for bankruptcy their business assets are sold for R800’000 and used to partially repay their debts. This may include complex legal matters because even though their debts aren’t fully settled, the courts will judge them settled because of their bankruptcy.
Budget
A combination of income and expenses. A budget usually pertains to a period of time like a year or a month. People and businesses use budgets to regulate their spending and to determine their profitability. Draw up your own budget to make sure you spend less than you earn. In so doing you can grow your wealth.
You can draw up a monthly budget with estimates of your projected income and expenses. Add up all your income like your salary, investment proceeds and business profits. Then subtract your expenses. Change your intended expenses so that it won’t exceed your income. Your expenses must be less than your income, or else you will lose wealth. Even if you spend money through credit cards and loans now, you’ll be required to pay for it later. So budget well to spend less than what you earn, and then keep to that budget.
Capital
Capital is the term used for financial assets in both forms namely assets or equity financing. Financing capital usually refers to the cost of a project. Capital may also be seen as a type of investment in a project.
Someone who joins a partnership usually needs to invest an amount of capital to become part of the partnership. Perhaps they need to invest a specific amount of money. Or they could possibly invest assets of the same value into the business.
Collateral
There are two forms of credit called secured debt or unsecured debt. The absence of collateral makes debt unsecured. The presence of collateral makes it a secured debt. Assets or similar things of value can serve as collateral.
A borrower can submit collateral for their debt. It decreases the risks involved for the lender, because the collateral serves as payment for the debt if the borrower defaults. The lender then offers a lower interest rate which cheapens the borrower’s credit payments. A property bought on a home loan typically serves as collateral for the said home loan.
Consumer
Someone who buys goods and services for personal use. Consumers don’t buy to resell.
Compound Interest
Interest increases whatever it is applied to. But over time interest is added on interest. This is called compound interest (when interest is added to interest). The power of compound interest on a specific financial tool increases as time progresses. This gives way to exponential growth possibilities wherever compound interest has enough time to work its magic.
An investment of R1000 with an APR of 5% increases with R50 of interest in the first year. The following year it’s worth R1050 and increases with R52.50 (on an APR of 5%). But let this run for 60 years and you’ll see the exceptional power of compound interest. At the beginning of the 60th year, the investment is worth R17’789.70 and with the same 5% APR, it increases with R889.49. In year one the investment increased with R50 but in year 60 it increased with R889.49 even though the APR remained the same because compound interest had time to accumulate more momentum.
Credit Card
A form of debt offered by lenders. A credit card is linked to an account with a maximum limit and an interest rate. The credit cardholder can use money up to the maximum limit but has to make monthly payments based on the interest rate applied to the credit card.
You can’t spend more than the limit if it’s R5,000 for instance. The outstanding balance accrues interest over time, according to the facility’s APR. Some credit cards have a type of grace period that could last up to 55 days. It only accrues interest after the grace period ends.
Creditor
This can be either a business or a person you owe money. For example, any suppliers you owe money are your creditors.
Creditworthy
A lender wants to know if a borrower can manage credit. They will only approve loans to those who prove their ability to repay it. People who are able to repay a loan are creditworthy.
Your creditworthiness is reflected by your credit score. A higher score indicates a stronger creditworthiness.
Cryptocurrency
A virtual currency that trades like any other currency but with no actual physical form. It’s a digital asset that serves as a medium of exchange. It uses a strong method of digital security called cryptography to guard against theft or fraud.
Some of the more popular cryptocurrencies are Bitcoin, Ethereum, Ripple, and Litecoin. They trade on specific platforms and serve as a way to store money. Cryptocurrency can be used to pay for goods and services at vendors who support the medium. Most people buy and sell cryptocurrency as a form of investment.
Debit Card
A plastic card that fits in a wallet. Bank customers use debit cards to access the money in their accounts. Swipe it at an electronic pay point to pay for goods or services rendered.
Debit Order
Recurring services or purchases usually offer debit orders as a means of payment. Services that require a type of subscription fee usually accept debit order payment methods.
You can set up a debit order to pay for something on a specific day of each month. This helps you to keep accounts up to date. Always make sure your bank account has enough available funds to when your debit order is set to go off.
Debt
Something that needs to be repaid. Debt can take the form of many things. Like a personal loan, car loan, home loan (mortgage), credit card, or even an overdue account.
Debt-to-Income Ratio
This is a way in which lenders measure your capacity for more debt. They take your monthly income and measure how much of it goes to monthly debt repayments. Your debt-to-income ratio (DIR) is 10% if you earn R1,000 per month and need to pay R100 per month to lenders. Your DIR is 80% if you earn R1,000 and must repay R800 to lenders. A high DIR is bad and a low DIR is good. Lenders will deny the loan applications of people with a high DIR.
Demand
The demand for a product or service refers to the need thereof. Demand could increase when things get scarcer. Demand could even refer to something like labour. For example, demand for health practitioners is high during a disease outbreak. A high demand usually drives prices higher.
The demand for the U.S. Dollar is higher than the demand for the South African Rand. More people want to buy Dollars than are willing to buy Rands. This is one of the reasons why the Dollar is stronger than the Rand.
Disbursement
This is when a loan pays out into your account. It could possibly refer to the transaction when a car dealership gives you the car you bought through a financed deal. In essence, it means a form of credit has been accounted to your name.
Dividend
Some companies pay portions of their profit to their shareholders. All shareholders are not entitled to dividends. It’s up to the discretion of the company board of directors to decide whether shareholders will receive dividends. It is not possible to pay dividends to shareholders if a company is making a loss.
For example, a dog food company makes a profit of R100,000. They have issued a total of 10,000 ordinary shares, which are owned by shareholders. They decide to pay a dividend of R2 per share. This means they’ll pay a total dividend from their profits of R20,000. Someone with 500 shares will receive a dividend of R1,000.
Entrepreneur
An entrepreneur finds a new business with an original concept. They use this product or service to provide value to their customers. They usually take on great risks in the process to generate more profit through their business.
Exchange Rate
The exchange rate is the value of one currency in relation to another currency, usually for the purpose of converting the currency to the other currency.
For example, let’s look at the US dollar as it is usually used as a universal global currency. Depending on when you read this, 1 US dollar is equal to 15 South African Rand. This means that if you want to buy $1 you will need to exchange R15 to get that $1.
Exchange-Traded Fund
This is a security (a type of investment) that consists of multiple stocks trading on the Johannesburg Stock Exchange (JSE).
Open an account with an authorised JSE Equity Member and buy your own shares in an ETF. Choose from various types that give you specific exposure to industries you might not be able to access without the help of an ETF.
FICA Documents
The documents required by a lender to verify your identity and income. The Financial Intelligence Centre Act 38 of 2001 (FICA) specifically exists to help fight financial crimes.
Lenders, therefore, need FICA documents to verify your identity. Official documents also help to prove your residential address and income. FICA documents foremostly help to stop identity theft crimes, because it stops someone else from borrowing money under your name. It secondly helps lenders to establish your capacity for credit. They want to know whether you can repay a loan before they approve it.
Fraud
A crime that implies the illegal use of a victim’s personal information and/or money. Both people and companies can commit fraud. Popular credit card fraud scams try to gain a victim’s credit card details to gain access to their money. Cases of fraud usually have a victim and a perpetrator.
Guarantor
Someone who signs with a borrower on a form of credit. They also accept responsibility for the debt with the principal beneficiary (the person to whom the loan is disbursed). A guarantor must repay the debt when the principal beneficiary can’t. It’s also called a cosigner.
Parents often sign as the guarantor for their children’s student loans. The student (the child) is liable for the debt, but the guarantor (the parent) is also liable for the debt if the student fails to repay it.
Gross Domestic Product (GDP)
The total value of services and goods sold by a country. According to the World Bank, South Africa had a GDP of $349.4 billion in the year 2017. The GDP of a country can be measured in any currency available on Earth. It’s just important to compare it to something measured in the same currency. The U.S. Dollar usually serves as the currency for international GDP comparisons. For instance, in 2017 Nigeria had the biggest African economy to a total of $375.8 billion.
Gross Income
The amount of income earned before tax and any other deductions. Your gross income is the salary you earn before your employer makes any deductions for tax, retirement, medical scheme deductions, or any other type of deductions.
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