Principal
When used in a business or legal context, principal primarily has two distinct meanings. In finance, the word principal can refer to the initial amount of investment or loan, while in business law, its definition may refer to a primary party involved in a transaction. You may also see the chief executive officer referred to as the principal of a company.
In business, you'll also see the term "principal address," which has an entirely different meaning. Your principal address or principal place of business is your primary business address. It's the main location where business is conducted. It can be your home, if you have a home-based business. It's the address registered with the state and is on the LLC articles of organization. Generally, it's the location you use to manage your business and where you keep your business records.
The importance of principal
Grasping the definition of principal is essential for business owners as it affects various aspects of corporate finances, from the interest calculations on loans to the returns on investments. Additionally, recognizing who or what constitutes a principal in a transaction is fundamental for contractual agreements and legal obligations.
Principal in finance and investment
In finance, the principal is the initial size of an investment or the original amount of a loan. It serves as the baseline for calculating your interest payments, profits, and other financial returns.
Principal in loans
For loans, the principal is the amount that a person or business borrows and is obligated to repay. When a business takes out a loan, the total cost of borrowing often includes principal and interest.
Principal in investments
In the investment world, principal refers to the original sum invested, excluding any interest or dividends earned. This amount is the principle definition for calculating the return on investment (ROI). Investors aim to recover their principal while making additional gains.
If planning for retirement, even in lean years, try to leave your principal practically untouched. The goal is that your accounts will continue compounding interest, even in years when you can't otherwise add to your retirement savings.
Calculating returns on principal
To calculate the return on principal for an investment, subtract the initial principal from the value of the investment at the end of the investment period. This calculation provides the net gain or loss on the investment.
An example in business
Imagine you own a business and you make an initial investment of $10,000 in a new project. At the end of the fiscal year, the investment is worth $15,000. Here, the principal (the initial investment) is $10,000, and the return on the principal investment is $5,000.
Principal as an indicator of a company's financial health
Knowing the amount of principal is essential to interest calculations. For business owners, a clear comprehension of principal amounts, how they are repaid, and their legal implications in transactions is crucial for informed financial decision-making. Smart management of principal can lead to more profitable business investments and better control over financial liabilities, contributing to a business' success.
Principal in business law
In business law, the term "principal" can have a different connotation. It refers to the main party involved in a transaction. This could be a person or entity who authorizes another to act on their behalf, such as in the relationship between a principal and an agent. The principal is responsible for the acts of the agent that are within the scope of the agency.
The principal-agent relationship
In the principal-agent relationship, the principal delegates authority to an agent to carry out specific tasks or make decisions, with the understanding that the agent will act in the principal's best interest.
FAQs
What happens to the principal over the course of a loan?
Over the life of a loan, the principal typically decreases as monthly payments that are made. In the case of an interest-only loan, the principal remains unchanged until the interest period ends, at which time the principal must be repaid.
Can the principal amount change in an investment?
In investments, the principal amount remains the initial sum invested. However, the value of the capital sum of the investment can increase or decrease depending on the performance of the investment.
How does the principal relate to a company's debt?
The principal amount of a company's debt is the sum the company must repay its creditors. It does not include interest or additional fees.
How can LegalZoom help with principal?
LegalZoom offers a broad range of essential services for small businesses and individuals, including legal and tax advice. One of our tax experts can provide advice about the tax implications of loans and interest payments.
LegalZoom can also help you with forming your LLC, so once you've supplied your principal business address to us, we will include that on your LLC articles of organization and any other documents that require that information, saving you time.