When you save or invest some money, you want to get the most return on it. This is the compound interest on the money. Interest lies under two categories: simple and compound. Simple interest is paid on the money saved or invested, while compound interest is paid on the investment plus the interest you have already earned on that investment. Compound interest, thus, allows a successful management of fluctuating cash needed by many small business owners. Poor cash management is the prime reason behind business failures. Forecasting aids businesses to determine when it needs money to be placed back into the work for equipment and other assets that will need a large chunk of money. It aids the business to save and make money in the future.
Compound interest is applied to an investment or savings. It is the interest added back on the principal sum, making the interest to be earned on the added interest during another compounding period. As a loan is taken, an interest is calculated for the first period, and this interest is added then to an original total. The interest then from the next period is calculated on the basis of a gross figure from the previous first period. This makes a compound interest. The compound interest is basically when the bank will pay interest on the principal or original amount of money, and the interest on an account that has already been earned. The compound interest raises over time. So the account will grow every year according to the balance of the account and the interest paid for the year that has passed. It is calculated per year, per month, per day, and so on. This will be done like this:
$1000 x 10% + $100
=
$1100 x 10% + $110
=
$1210 x 10% + $121
=
$1331 x 10% + $100… and so on..
It may sound complicated, but calculating it is much easier. Follow these steps to see how compound interest is calculated:
- The formula given below is used to calculate the compound interest. This is:
A = P(1 + i)^t.
A in the formula is the amount to be paid in total.
P is the principal amount.
i is the interest rate on the principal amount.
t is the time period for which the money is lent.
- With this formula, the values will be placed in. For instance, if the money borrowed is $3000 at a 10 percent annual interest for 2 years, the compound interest will be:
A = $3000 (1 + 0.10) ^ 2
= $3000 * (1.10) ^2
= $3420
Keep in mind that the principal value is the amount to be borrowed. The interest rate is an amount charged by the lender when they give the principal amount to the borrower. This interest rate represents a yearly rate of interest on a particular principal amount.
Related source: How to Make an IRS Payments Online.
Note: The above formula for compound interest calculates the future value of any investment or a loan as it has compound interest plus the principal. To calculate the compound interest only, you can use this formula:
Total compound interest = P (1 + i/n) (nt) – P
where n is the number of times the interest in compounded per year.
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