Accrued interest is a financial term that often confuses the small business owners across India. Understanding this concept is necessary, especially MSME owners who are frequently involved in financing their business with a business loan for MSME and other sources of investments. This guide aims to simplify the term accrued interest, particularly for Indian MSME owners.
What is Accrued Interest?
Accrued interest is the interest that has accumulated on a loan or investment but has not yet been paid. It’s like interest that’s building up on a credit card, waiting to be charged. This gets compounded over time and becomes a very big financial problem for an MSME and can put further and growth of the particular business at stress, so it is important to identify such accrued interest and to take necessary measures to solve it at the earliest.
The Difference Between Interest and Accrued Interest
- Interest: This is the cost to be paid for borrowing funds from the lender. Which is technically the purpose of the lender for giving money to an MSME business. This is agreed upon before giving out the loan.
- Accrued Interest: This type of interest is different as this only gets built up over a specific period, but hasn’t been paid yet. This interest gets on increasing on a daily, weekly and monthly basis. Keeping an eye on it can save the borrower a lot of money. However from the lender’s point this could make things favourable.
Types of Accrued Interest
- Simple Interest: This is the most basic type of interest. It’s calculated on the principal loan amount issued to you by the lending party.
- Compound Interest: This type of interest is calculated on both the principal amount and the accumulated interest. It’s often used in personal savings accounts and other types of loan types given out by financial companies and banks.
How to Calculate Accrued Interest
To calculate accrued interest, you need to know the following:
- Principal Amount: The initial amount of the loan or investment.
- Interest Rate: The annual interest rate charged on the loan or investment.
- Time Period: The length of time for which the interest is being calculated.
The Formula for Simple Interest Accrued Interest:
Once you have all the 3 key necessary factors as shared above for calculation of the accrued interest, you can proceed to using the below mentioned formula, alternatively you may also use loan calculators available online if that makes it easier, we would recommend an MSME owner to have this formula memorised to calculate accrued interest%. .
Accrued Interest = (Principal Amount × Interest Rate × Time Period) /365
The Impact of Accrued Interest on Business Loans
Accrued interest can significantly impact the total cost to be paid for an active business loan, regardless of whether it is a collateral-free business loan or of secured type. Here’s how:
- Increased Debt: As interest accrues, the total amount to be repaid by the MSME also increases, even if you haven’t made a payment yet to the lender.
- Higher Interest Payments: The payment amount is only going to increase as the accrued interest increases, this can have significant impact on any MSME.
- Potential for Default:The last thing an MSME business owner would want to be is to be a defaulter on an MSME business loan. Accrued interest rates therefore should be closely monitored to ensure they don’t put you at disadvantage.
Conclusion
Knowing accrued interest, understanding its potential effects on one’s business is essential for any business owner regardless of whether you are MSME or corporate. By knowing how it’s calculated and how it affects your money and the risk it can have in your business, you can make wise decisions about your loans and investments.
By staying informed and taking proactive steps to manage your finances, you can ensure that your business continues to thrive.