Interest rates and how to calculate them Interest rates affect us all, this could be
anything from the amount of interest we receive on our savings or the amount of interest we
are charged on a loan and this is no different in the world of business.
Let’s have a look at what interest rates are, how they impact businesses, and how they
are calculated.
Put simply, interest is the reward for lending money and the cost of borrowing it.
In business, money is often borrowed to not only survive but to also finance projects
and activities such as expansion and refurbishments.
When businesses borrow money, they are often charged interest which essentially means they
will pay more back than they initially borrowed.
For example, if a business took out a bank loan with an annual interest rate of 8%, this
would mean £8 of interest is paid for every £100 they borrowed.
However, interest rates vary over time and its very important businesses are aware of
any changes when the Monetary Policy Committee sets the Bank of England Base Rate with the
aim of meeting the government target of keeping inflation low and stable.
This base rate influences the interest rates that banks charge people and businesses to
borrow money or pay on their savings.
Essentially, to cover their costs, banks need to pay less on saving than they make on lending.
When the interest rate does change, it can impact businesses in multiple ways which will
vary from business to business.
Whilst a rise in the interest rate typically signals that the economy is robust, businesses
with company credit cards and existing loans can have higher interest payments as the cost
of borrowing increases, they may also have less disposable income, and bigger overheads
when interest rates are increased which can severely impact cashflow.
Also, customers will typically spend less money when interest rates are increased as
they save more and borrow less which has a negative impact on the profitability of businesses
in general but especially for those which sell luxury non-essentials products.
So, that’s a quick introduction to interest rates and how they can impact businesses,
let’s now have a look at the method which is used to calculate the interest on a bank
loan.
To calculate the interest rate on a bank loan as a percentage, a formula is used which is
the total repayment minus the amount borrowed divided by the amount borrowed multiplied
by 100.
However, this can be broken down into three simple steps.
Step 1 is to subtract the amount borrowed from the total amount to be repaid.
Step 2 is to divide the answer from step 1 by the amount borrowed
Step 3 is to multiply the answer from step 2 by 100.
The answer you get once you have completed step 3 is the interest rate and should always
be expressed as a percentage.
So, now we know the method.
Let’s have a go at a business scenario requiring us to calculate the interest being charged
on a bank loan.
Let’s say we have a scenario where we have a business which has taken a bank loan for
£25,000 but has a total repayment of £27,000, what is the interest rate charged on the bank
loan?
Pause the video and have a go, see if you can calculate this correctly.
Right then, lets go through the calculation to see if you managed to identify the correct
interest rate which was applied to the bank loan in this scenario.
So, Step 1 is to subtract the amount borrowed from the total amount to be repaid.
Which in this scenario £27,000 minus £25,000 and gives us an answer of £2,000.
Step 2 is to divide the answer from step 1 by the amount borrowed.
Which in this scenario is £2,000 divided by £25,000 and gives us an answer of 0.08.
Step 3 is to multiply the answer from step 2 by 100.
Which in this scenario is 0.08 multiplied by 100 and gives us an answer of 8.
Always remember to express this answer as a percentage, which means the rate of interest
charged on the bank loan was 8%.
So that’s it, a quick introduction to interest rates, how they impact businesses, and how
to calculate them.
I hope that’s helped and if you want to learn more about business, don’t forget
to subscribe to Two Teachers on YouTube to see our weekly video uploads on key business
topics.
Thank you for listening and all the best.