George S. Chua l August 7, 2024 l Business Mirror
UNDERSTANDING what is your friction cost in any financial transaction is something you need to know and understand, to know what your real cost is. Essentially, this is the additional cost in doing a transaction such as making a remittance, buying or selling fixed income securities, equities, unlisted shares, making any asset transfer, doing foreign exchange transactions and anything that involves money or property.
Frictions costs can be broadly classified into the following types, namely: fees and commissions, spread, float, taxes and your cost in terms of time and effort. Fees and commissions are normally the charges that are imposed on the transaction by the bank, exchange or any other institution where the deal is executed. Keep in mind a couple of things, first is that there could be more than one insti-tution involved which may mean that you pay more than once. Second, is that these fees and com-missions can be either be a flat charge amount or a percentage of the transaction. As an example, when you want to make a cash withdrawal using an ATM outside of your Bank Network, the fee will range from P10 to P18.
A spread is the difference between the buying and the selling rate, meaning the dealer will buy something from you at a lower price and sell the same thing to you at a higher price. It is also possi-ble that not only do you have to take a hit on the spread but sometimes on top of that they still charge a fee or commission! A very common example of this is whenever you travel abroad, we would typically not have the currency of the country we are visiting. And since our peso is not as easy to convert abroad, we normally bring US dollars with us. Upon arrival, we convert our dollars to the local currency. When you leave and want to convert the local currency back into dollars, you will need more of the local currency to get the same dollars back. It is not uncommon for money changers and banks to make a spread of 5 percent to 10 percent!
A float is something that most people do not think about. When you pay your bills or make a remittance, most likely, the payment will only be reflected the following day and sometimes after several days. You hand over your money today but the application of that money only happens after a day or so. Your money is effectively in limbo where it is no longer in your bank account but not yet received by the intended party. This is what is known as the float enjoyed by the financial intermediary, where they get “free” money. Imagine this happening every day and in amounts that become huge on a cumulative basis. This float money can earn interest in the overnight markets or other placements.
Taxes charged by the government can come in various forms. Common examples include the documentary stamp tax on the exercise of certain rights, withholding tax on salaries, interest income and payments, value added tax on sales transactions, capital gains tax, income tax, excise tax, tariffs, customs duties and taxes, franchise fees and so many others. Practically all types of business activities and financial transactions are taxed by the government and in many cases, there is even a double taxation.
Finally, you should take into account your total cost in doing a transaction, including your time and effort. Think about it, whatever salary you get does not all translate into free and available cash to you. Part of that salary needs to be used as an expense to actually get to work and spend the time at work such as your transportation costs, uniform or clothing at work, and meals.
You should also consider the type of work that you do, the time you spend, the stress you encounter, the work environment and the risks you take on the job and getting to work. Knowing your friction costs will enable you to properly evaluate if something is worth doing.
*** The views and comments of Dr. George S. Chua are his own and not of the newspaper or the Financial Executives Institute of the Philippines (Finex). The author was 2016 Finex President, 2010 to 2020 FPI President, an active entrepreneur in fintech, broadcast, media, telecommunications, properties and a regular member of the National Press Club. Dr. Chua is also a Professorial Lecturer 2 at the University of the Philippines Diliman and BGC Campus, a Trustee of the Finex Foundation and the Vice Chairman of the Market Governance Board of the Philippine Dealing and Exchange Corp. Comments may be sent to georgechuaph@yahoo.com or gschua@up.edu.ph.