Economic Terms

Concepts useful for assessing feasibility studies and business plans

The annual rate of return on an investment, which is usually expressed as a percentage figure. It is a forward looking (prospective) measure and normally is a predictor of what the return on investment of a project is likely to be.

This too is a measure of the return on investment of a project, however it is a backward looking (retrospective) measure. It measures how much profit a company or project did in fact generate given the money that was invested by its shareholders.

This is a measurement tool used by investors to assess if a project is worth investing money in or not. It is closely associated with the concept of a project yield as it measures the projected annualized compounded rates of return (yields). A project is a good investment if its IRR is greater than the rate of return (yield) that could have been earned by investing the money in an alternative investment. It is therefore also often referred to as a “hurdle rate” as a project would have to produce a certain yield, before investors would consider investing in it. For example if an investor had a R100 000 which he could invest in a bank and earn 12% interest on it a year, if you want him to reconsider and invest in a project of yours, then your project would have to produce an IRR that is greater than 12%, say 15% before the investor would consider investing his money in your project. This is because he would be taking on more risk when investing in your project than when investing in a bank and therefore he would expect higher rates of return.

When investing money, this can also be linked back to the IRR as the opportunity cost is the next best alternative that has to be sacrificed whenever an economic decision is made. So in the example above the opportunity cost of investing in the project would be the 12% that the investor could have earned had he invested the money in the bank.

This is a term describing the rate at which income growth in a project or company compares to the rate of expense growth.

This is something of value (could be property, or money, or shares) that is pledged as security for a loan. This item of value can be claimed by the lender if the loan is not repaid.

A loan in which the fee or interest charged does not change throughout the term of the loan.

This is when there is co-operation or joint ownership on a project or business between two or more corporate bodies.

A financial obligation, debt, claim or potential loss faced by a company.

This is the process which is undertaken when terminating a business, which normally includes the selling of the assets of the business to obtain cash and pay off the debts owing by the business.

These are highly specialized investment companies which buy partial ownership in start up companies that need money to get their business off the ground. They normally are involved in funding high risk activities and therefore expect high returns.

This is the term that is used to refer to the money that is invested by the venture capital funds to start up new businesses.

This refers to the extension of small loans to people who would not have the means or assets behind their names to qualify for traditional bank loans.

This is the money that comes into a company from sales or goes out in purchases or overheads. When assessing feasibility studies it is cash flow analysis that becomes critical in determining if a project will be able to survive or not.

This is the same as gross profit, which is the net sales of a company or project minus the cost of the goods and services sold.

A term used in business and marketing to identify a specialized or targetable part of a market.

When assessing projects one knows that money earned in the future will be of less value than money earned now, due to yearly inflation devaluing what money is worth. When determining if a project is viable or not one has to assess projected cashflows that are going to be earned in the future. However to get an understanding as to what those future earnings would be worth in today’s terms one has to discount the future cashflow using an interest rate that reflects the fact that money in the future is worth less than money now. This helps in determining if the project is worthwhile or not as if the calculated present value of the benefits exceeds the costs then it is a worthwhile investment.

The net present value compares the value of a rand today to the value of that same rand in the future, taking inflation and returns into account. If the NPV of a prospective project is positive it should be accepted. If it is negative the project should be rejected because cash flows will also be negative. The NPV is calculated by discounting the cash flow.

If a deposit account of R100 earns an interest rate of 10% a year, then at the end of the year the account will contain R110. If all the money is left in the account then the 10% interest will be paid on the R110, so at the end of the second year R11 of interest will be added, making R121 in all. This is known as compound interest. By contrast simple interest means that the 10% will only be paid on the original sum in the account.

This is a loan arrangement in which repayments only cover the interest amount and do not reduce the outstanding initial amount of capital loaned. This capital is paid back at the end of the loan period. This can also be called a non-amortizing loan.