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chapter 13 page 2

S

salj67

Member
Under intrest payments.
Could someone please explain with an eg how profits are understated due to inflation?
 
Hi salj67

Say you borrow 100 and pay interest of 5 over the year, and repay the 100 in 1 year.

Inflation will mean, for example that the borrower needs 103 now, to be able to afford the same things that 100 would have bought last year. So part of the interest repayment (3 of 5 in this case) is compensation for inflation.

In times of high inflation, the interest payment will be higher (eg if inflation becomes 7 interest rates may increase to 9), and so the profit after interest will be lower.

Hope that helps

Best wishes
Stuart
 
Interest rates

If fixed-interest debt is issued, then yes, for now.

But interest rates are likely to rise in response to an increase in inflation, and then any further borrowing the company requires is likely to reflect this rate.

Best wishes
Stuart
 
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