Interest is a cost, principal is a claim
Morrow Bikes wants a second lift and a deeper parts shelf, so the bank lends it $10,000 at 8% for five years. The cash lands on Monday. Nothing has been sold, nothing has been earned, and the bank now has a claim on the shop.
Borrowing puts cash in and a claim on the Snapshot, at the same moment. On the Snapshot (balance sheet), cash rises by 10,000 and debt rises by 10,000. The Scorecard (income statement) does not move. This is a Snapshot question, and the reflex is the one this whole stage sharpens: whose claim?
Interest is the price of the money; principal is the money itself. Interest is an expense on the Scorecard. Repaying principal shrinks the bank's claim and never touches profit. Confuse the two and both profit and cash flow come out wrong.
One year of the loan
Interest for the year is 10,000 × 8% = $800. At year end Morrow pays the bank $3,000. The first 800 covers the interest; the remaining 3,000 − 800 = $2,200 repays principal. Closing debt is 10,000 − 2,200 = $7,800. The Scorecard shows $800 of expense, not $3,000. The other 2,200 changed the Snapshot and nothing else.
Repeat the same $3,000 every year and the split shifts. Year two starts at 7,800, so interest is 7,800 × 8% = $624 and 3,000 − 624 = $2,376 goes to principal. Each year the interest slice shrinks and the principal slice grows, because interest is charged on a falling balance.
Not all debt is the same debt
Debt comes secured or unsecured, senior or subordinated, fixed-rate or floating-rate. A fixed rate protects against some rate rises but not against maturity. When the loan comes due it must be repaid or replaced, and the chance that it cannot be replaced on acceptable terms is refinancing risk. A floating rate can raise the interest bill with the principal unchanged. Fees, discounts and hedges all move the real cost away from the headline rate.
Morrow pays the bank $3,000 at the end of the first year on the $10,000 loan at 8%. How much of that payment is an expense?