Debt is Expensive to Communities

Updated: Aug 29, 2018

Debt Finance with Interest. Prepayment Finance with Discounts

The cost of Debt is Interest. But, for a community of borrowers and lenders the cost is at least double the cost of Interest to the community. The diagram above gives the reason. When individuals in a community borrow money and repay the money with interest the cost to the community is the amount of money borrowed plus the interest. When community members lend to each other and get the same return as debt through discounts on prepayments the money cost to the community is the amount of money minus the interest.

For the community Interest is money that goes out of the community and Discounts is money that stays in the community. For a community they are real costs, not bookkeeping entries.

Traditionally organisations borrow money to fund the development of products and services. The organisations repay the money plus the interest charges. They get the money to repay from future sales.

Let us assume the amount borrowed is X and Interest is I then the organisation repays X + I. To achieve a profit it needs to increase the price of goods by X + I. Assume the gain from sales is P, sales are S, and the cost of products sold is C.

S = P + C + X + I.

Alternatively, organisations can borrow from their customers and give the customer discounts instead of interest. With discounts S = P + C + X — I

If S, P, C and X are all the same value, then using discounts instead of debt saves a community at least 2 times I in real money.

More Savings

With debt interest increases with the passing of time. Interest compounds, so it makes sense for the borrower to pay off debt as quickly as possible while the lender would like the loan to continue forever.

Discounts increase with the passing of time, but they do not compound, are a linear function with time and so cost less than interest. A buyer of prepayments often prefers to leave the money while the borrower wants to pay it off as quickly as possible. This favours long-term returns rather than short term and this results in lower overall costs.

Further administrative savings come because debt requires a separate process from payments while prepayments use regular invoicing and so remove the administrative costs of loans.



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