Estimated reading time: 5 minutes
“It takes money to make money” is a popular saying in the business world. If you run a small business, you have probably heard or even said it many times. That’s because money is needed to launch any business startup and is also required once a business is up and running. The myriad costs associated with keeping your business moving forward are, obviously, dependent on your industry and the size of your company.
When the time comes to shore up your cash flow, pursue a new growth opportunity, buy a new piece of equipment, cover the costs of your daily expenses, or consolidate debt, you have many options to choose from. These include small business loans, business credit cards, and other forms of credit. However, before you apply, it is good to look at the annual percentage rate (APR), which shows you how much it costs to borrow money and how much it costs to carry a balance on a business credit card from month to month. If you want to understand APR better and how it works, this blog post from Balboa Capital can help. It features an annual percentage rate guide.
Annual percentage rate definition.
APR is an acronym for annual percentage rate, which is the total cost of borrowing a specific amount of money on a yearly basis. It is important to remember that the APR differs from a business loan’s interest rate. The APR includes the interest rate and any other costs associated with a loan, such as a loan origination fee. The amount of the loan and the term length will also impact the APR, with longer terms genuinely having a lower APR. For example, if you take out a $50,000 loan with 8% interest, a 3% origination fee, and a 12-month repayment term, the APR is 13.77%.
|Total of 12 payments||$52,193.06|
|All payments and fees||$53,693.06|
The same loan scenario with a 36-month repayment term will have a lower APR (10.08%) and lower monthly payments, but the overall cost will be higher.
|Total of 12 payments||$56,405.46|
|All payments and fees||$57,905.46|
How to calculate APR.
Calculating the APR of a business loan is relatively simple, so long as you have readily available the required information about the loan. For example, you will need the loan amount, the interest rate, the repayment term length, and any loan-related fees. The APR formula is:
Interest + loan fees ÷ principal ÷ number of days in the loan term x 365 x 100
Let us use a welding business as an example. The business owner borrows $10,000 at a 7% interest rate for two years (24 months). The loan-related costs total $1,000. These steps show you how to calculate the APR for this scenario.
Step 1. Add the total interest paid to the loan-related fees.
$700 + 1,000 = $1,700
Step 2. Divide $1,700 by the amount of the loan.
$1,700 ÷ $10,000 = 0.17
Step 3. Divide 0.17 by the number of days in the loan term.
0.17 ÷ 730 = 0.00023288
Step 4. Multiply 0.00708333 by 365 to get the annual rate.
0.00023288 x 365 = 0.085
Step 5. Multiple 0.085 and 100 to get the APR.
0.085 x 100 = 8.5% APR
APR versus APY.
APR provides you with the actual cost of a loan, but it doesn’t reflect the compound interest rate earned on business savings accounts. For this reason, it is essential to look at the annual percentage yield (APY), also known as the earned annual interest rate (EAR). Perhaps the easiest way to differentiate between APR and APY is that APR includes interest owed, and APY includes interest earned.
A high APY will generate more money for you. So it makes sense to look for a high-interest savings account for your small business. Just remember that APY does not consider any fees associated with managing your savings account.
Loan origination fees.
Origination fees cover the costs associated with reviewing and verifying the information on a loan application and processing the application. Business loan origination fees typically range from 1% to 5%, depending on the length of the loan, your credit profile, and your income.
Some lenders charge a flat fee based on the loan amount. If you cannot afford to pay the origination fee upfront, you might be able to add it to your loan balance. Some lenders do not charge origination fees for specific business loan amounts, but reading the fine print is a good idea. There might be higher interest rates or penalties for paying off the loan early.
Business credit card APRs.
In the case of business credit cards, the APR and interest are the same amounts, and you only get charged interest on how much you owe if you carry a balance each month. So, if you have a business credit card with a $20,000 limit, charge $8,500 one month, and pay off the balance on or before the billing cycle due date, you will not have to pay any interest charges. However, if you don’t pay off the balance or choose to make a minimum payment, you will be charged interest on the balance due. In addition, if you miss one or more payments, penalty fees may be applied to your current balance. Plus, late or missed business credit card payments can negatively affect your credit rating.
Most business credit cards have variable APRs that range between 15% and 25%. The APR is determined by the prime rate, which the Federal Reserve sets. Banks and lenders use the prime rate to determine interest rates on all types of business funding and credit products. A business credit card with a high APR means that you pay more interest for credit card debt repayment, and a business credit card with a low APR offers lower payments. Many small business owners find that their credit scores improve due to using a credit card. This is because the cards are a tool for managing their finances and building good credit-building habits.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.