Updated: Sep 19
Interest rates are a ubiquitous force that influences our financial lives in more ways than we may realise. Whether it's the interest we earn on our savings or the interest we pay on a loan, the impact of interest rates extends to the world of business as well.
In this blog post, we'll delve into what interest rates are, how they affect businesses, and the methods used to calculate them. So, fasten your seatbelts, as we embark on this fascinating journey.
Learn more by watching the video and reading the blog post below:
To put it simply, interest is the reward for lending money and the cost of borrowing it. In the realm of business, money is often borrowed not only for survival but also to finance various projects and activities such as expansions and refurbishments. However, when businesses borrow money, they are charged interest, which means they will end up paying back more than they initially borrowed.
For example, imagine a business taking out a bank loan with an annual interest rate of 8%. This would imply that they pay £8 of interest for every £100 borrowed.
It's crucial for businesses to be aware that interest rates can fluctuate over time, as determined by the Monetary Policy Committee setting the Bank of England Base Rate, which aims to maintain low and stable inflation. The base rate influences the interest rates that banks charge individuals and businesses for borrowing money or paying on their savings. To cover their costs, banks need to pay less on savings than they make on lending.
When interest rates change, businesses are impacted in various ways, and the effects can differ from one business to another. While a rise in interest rates typically signals a robust economy, businesses with company credit cards and existing loans may face higher interest payments, increased costs of borrowing, reduced disposable income, and higher overheads. These factors can severely impact cash flow. Furthermore, when interest rates increase, customers tend to spend less money, save more, and borrow less. This reduction in consumer spending can have a negative impact on the profitability of businesses, especially those selling luxury non-essential products.
Now that we've explored the basics of interest rates and their impact on businesses, let's shift our focus to the method used for calculating interest on a bank loan which can be found in the video if you've not already watched it.