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The term simple interest is defined as an investment that yields a constant proportion of returns per time period. For example, if you invested $1,000 in a savings account that earns 1% per year, it would earn $10 every one year, or a 10% return on your initial investment.
This is called direct proportional growth because the income grows by ten times every twelve months or a proportionally higher amount each time frame.
However, this kind of growth does not occur very frequently and is usually limited to short periods of time. This is why most people prefer compound interest over simple interest.
Compound interest happens when your principal (what you start off with) is reinvested back into the loan for additional credit. This increases the total valueof the investment!
In business studies, we will be talking about both how to calculate simple interest and how to calculate compound interest.
Compound interest is when interest accumulates over time, with each additional payment adding onto what was paid before.
Simple interest is when one amount is added to another without any extra additions. Each month, you add up how much money you want to make and multiply that by the number of months it takes to make your goal.
This way, the monthly payments increase more quickly, but the overall cost stays the same. This is why people say things like “pay twice a week” instead of saying “pay every two weeks.” They mean the same thing but are just using different terminology.
By this definition, compound interest is when you pay yearly, whereas annualized simple interest is paying monthly. These differences can have significant impacts depending on what you want to achieve.
If you wanted to make a certain amount of money in a year, then annually would be better than monthly because you get a higher return for the investment. If you only need so many months to meet your goals, then monthly will work better.
There are also times when it is difficult to come up with the needed amounts for both weekly and monthly calculations.
There is an important difference between compound interest and simple interest. With compound interest, your interest level rises more quickly over time. For example, if you have $1,000 and invest it at 10% per month for one month, then each day that passes, your investment grows by 10%.
So even though there are only 30 days in a month, your investment doubles every single day! This way, your investment grows much faster than investing the same amount in a monthly basis which would only grow proportionally with time.
This is why some people win the lottery or earn a lot of money in their lives, they keep buying things because they want to see how far their investments will take them. They think about what they’ll do next year, not this week!
On the other hand, individuals who understand basic business studies know that spending money to make purchases now is a good way to increase income later. It’s called “paying yourself first” or “putting away something for yourself”.
This can be done through daily savings, weekly savings, or monthly savings. No matter which option you choose, your self-confidence will rise as you nest eggs for your future lifestyle.
When calculating simple interest, you have the amount of money that is being invested determined along with the time frame. The time frame can be for monthly or yearly, but usually it is annual. Then, you use these two numbers to calculate how much more or less your investment will grow.
The equation used to do this is dependent on whether the principal is repaid or not. If it is, then the term comes before the principal, and if it isn’t then it goes after.
By using the terms before and after the principal, we get our final formula. So, let us look at an example!
Example: What are royalties? They are like income from investments. Let’s say I own a business and I want to know my royalty rate. My business earns $1,000 per month and I wanted to know what my royalty was.
My royalty is one fourth of my revenue which means it is 1% or $100 per month. This adds up to about $12, 000 every year!
This way of thinking about dividends makes them seem very lucrative because you get such a small part of your company’s profits each month. But remember, you are taking away almost all of the profit just giving back some of your earnings!
Another important thing to note about dividends is that they don’t fluctuate too much.
The other way to calculate simple interest is by calculating how much interest an amount of money will earn per year, then multiplying that number by your investment length. For example, if you have $1,000 and want to know what percentage of it will be earned back in one year, then divide 1000 by 1 (the period) for a 100% return on its own. Then multiply this value by twelve, which is a typical annual payment term for a monthly account! This calculation can easily be done using a calculator or via online calculators.
This method assumes that the money being invested grows at a constant rate, which isn’t always the case. But for most small business owners, it’s enough as a general rule of thumb. You should also remember that not every month has thirty days, so when doing these calculations, use a twenty-four month average instead.
The second way to calculate simple interest is by using the standard formula. This includes adding up all of the payments and then multiplying this total by the percentage used for each payment. For example, if there are three pay periods with an annual rate of 20% per period, then 30% for the whole year, and you want to know how much money you would make in one month, then just add up the monthly percentages (20%, 10%, 5%) and multiply this number by itself, or 1/12th of the amount wanted.
So, let’s do an exercise!
Imagine that you have $1,000 and you want to know what percent of profit you will earn in one week. Your weekly proportion is equal to one seventh so go ahead and work out the math!
$1,000 x 0.07 = $70
That equals 70 cents of your income as a proportion of profits. Now, we can use the ratio of proportions to find the yearly equivalent!
We already calculated the weekly proportion, now we need the yearly one. We take the quotient of the two and divide it into the other value to get the equivalent yearly proportion. In our case, the quotient is 3 so we put 3 into the other side to get.07 which is our yearly proportion.
Now, simply add these together to get the answer!
3 +.07 = $0.
The second way to calculate simple interest is to find the present value, or what the investment is now worth. This can be done by using the equation below.
Present value = (1 + r)^(timeframe) * NPV
Where timeframe is how much time you want to add onto the investment, r is the annual rate of interest, and NPV is net profit after tax.
You then need to multiply this amount by 1+r to get the final PV.
So for our example here, we will use investing in a house as an example. Let’s say your savings are £10,000 and you wanted to know the price of a one-bedroom apartment in a city that costs £400 per month to rent.
Your monthly income is ÂŁ3,600 so your net spend is ÂŁ660 per month. You would like to own your home so it is a depreciable asset so no capital gain is desired.
The next way to calculate simple interest is by creating a formula for calculating simple interest with a loan. This can be done using the proportionality rule as your main component.
The proportionality rule states that every term divided into another one produces a percentage. In our case, the percentages are called fractions. So, we will use fraction equivalents to create our simple interest equation.
A common way to do this is to take the principal amount of money being invested and divide it by the rate you want to find the simple interest cost per month. For example, if there was $1,000 invested and you wanted to know the monthly simple interest cost, then you would simply take 1,000 and divide it by 0.5%.
So, what does all of this mean? It means that the half of the $1,000 investment is $500 per month that has simple interest attached to it! Or, said differently, it takes half a year to pay off the initial $1,000 investment because you get paid back half of the principle each month.
Credit cards make it easy to calculate simple interest. You can use your credit card to pay for items directly, or you can have the store add interest to your bill.
Most credit cards come with an annual fee that includes a free credit score check. This is important because your monthly payment will include both the balance of the loan and the cost of the credit score check.
By having a good credit score, you’ll be able to get a lower rate on the rest of the loans and bills. Therefore, this cost is already paid for by the bank!
Another way to do this calculation is to transfer the debt from one creditor to another. For example, say you have a $1,000 personal loan at 10% per year. Your payments would be $100 per month.
You want to reduce your personal loan so you go find a lender that offers much better terms than what you have now. A new lender may offer you a zero percent yearly interest rate instead!
That means you would only need to pay their service charge which usually ranges between 2-6% depending on the company.
