We all grew up learning various subjects in school, but finance is not the subject that is being taught and still we need it everyday and I know lot of people struggle to understand even the simpler topics like interest rate, compounding and so on. The basics of finance is easy to understand, but hard to implement. In this topic I will shed some light on basics of finance that we may know and all use in our daily life but still do not the understand it intuitively.

1. Interest Rate
2. Compound Interest
3. Tax
4. Assets
5. Liabilities

1. Interest rate

I guess most of you are familiar with the first topic that is Interest rate. I think the most used word in the finance world is the term Interest. For example when you take out a loan, you have to pay interest on the amount of the loan taken. If you invest your money in the Banks Savings account, you will earn interest on the amount of the money in the savings account. Apparently interest is just the application of percentage, a basic concepts in mathematics most of us are familiar with. In other words interest rate is percentage of some total amount. For example, a bank is giving loan at 10% interest rate means that on a loan of 100 units you have to pay 10 units as interest. In terms of the savings interest rate, when a bank gives 7% interest on savings account then you will earn 7 units per 100 units of amount deposited in the savings account. This is interest rate.

2. Compound Interest

Now that you understand what an interest rate is, we can move on to the next topic called the compound interest. This can be best explained with the help of an example. Suppose you invest 100 units at 10% interest rate for one year. At the end of one year you will get 10 units of interest on the total amount. It is called simple interest. Now you hold this investment for one more year, you will earn another 10% interest on the total amount. But now the total amount is 110 units(100 units + 10 units), so you will get 11 units now. This is called as compounding effect i.e interest on interest. The growth here will be exponential after couple of years. There are many compounding calculators available on the internet and you can check that amount can grow exponentially. Albert Einstein once said that ” Compound interest is the eight wonder of the world. He who understands it, earns it. He who doesn’t pays it.

3.Tax

Tax is defined as contribution out of your hard earned money to the government who then uses it for development of the society. Now a days there are n number of taxes such as income tax, property tax, value added tax and so on. Again we use percentage here, Tax is calculated as a percentage of total value. If you are earning 10000 units of money and the tax rate is 20%, you will have to pay 2000 units of your money to the government. Which makes your actual earning 8000 units.

4.Assets

Assets are defined as an item or property that has economic value and can also have the ability to generate income. There can be many types of assets that can be both physical and and in the electronic format. Examples of assets include but are not limited to land, gold, cash, stocks, commodities such as oil and crops, etc. To give you a gist of how an asset work, here is an example of a type of asset. A man who purchases a land for some amount of money, which he can then rent out to some one else, hold it for sometime and sell it at higher price(Value appreciation) and if it is a farming land he can grow and harvest crops on it and earn income. This is how an asset can work for you to earn your income.

5. Liability

Liability is opposite of what an asset is, it is typically an amount of money that you owe to someone, such as loans, mortgage etc. Having a credit card bill is a liability. Even the tax that you owe to the state or government is a liability. Having a more liability than assets destroys the value and hinders the process of creating assets and earning positive income.

Now you understand some of the basic concepts of finance. Hope you find this article helpful. Please feel free to give your feedback and tell me if any topic you want to understand. Until next time. Peace.