A business savings account can be a useful tool for small-business finances. Business savings accounts can help your business keep extra cash on hand to deal with emergencies, help you smooth out your cash flow and save up for larger planned expenses.
Business savings accounts also offer interest, so you can make more money while you’re saving. While the interest rates available on most business savings accounts may not be very high, these accounts do allow you to earn something for depositing your funds.
What Is Interest?
When you deposit your funds in a savings account, you are actually lending that money to the account provider. Interest is the return you receive for letting the provider have access to your funds and is calculated as a percentage of your principal amount.
The same interest rate can yield different results depending on how it is applied. Simple interest, for example, means that the interest rate is applied only to the principal (the original amount of funds) just once.
For example, using simple interest, if you have $1,000 as the principal balance and an annual interest rate of 1%, you will earn $10 per year in interest on that $1,000, applied and paid once per year.
Most business savings accounts use compound interest. This means you can earn interest not only on your principal, but also on any interest that is added to the principal. Accounts that use compound interest calculate the interest at regular intervals, such as daily, monthly or quarterly, and add the interest to the principal amount. At the next calculation interval, interest is applied to the new principal amount, including the interest earned in the previous interval.
For example, if daily compounding is used, the balance that earns interest grows by 1/365th of the interest rate every day. In the example of an account with principal of $1,000 and a 1% interest rate, the account will have grown to $1,010.05 after a year.
This may be a small amount in this example, but it shows how compound interest can add up over time. Compound interest has a snowball effect because the principal can grow with every interval as interest is added. In general, the more frequently interest is compounded, the faster your savings will grow.
Annual Percentage Yield (APY) vs. Annual Percentage Rate (APR)
Most business savings accounts express the rate of interest that your account will earn in terms of Annual Percentage Yield, or APY. This reflects the rate of return you can expect to earn over the course of a year, including compound interest. The APY is calculated assuming that the original principal amount will stay in the account for the whole year. In contrast, a simple Annual Percentage Rate (APR) does not include the effects of compound interest.
Calculating Your Interest Earnings
Numerous online calculators and spreadsheets allow you to determine how much you can earn on your savings, depending on factors including:
- Interest rate or APY
- Principal amount
- Frequency of interest compounding
- How much you plan to add to the balance
Doing these calculations can give you a concrete idea of how much you will be able to earn in interest at any given rate. While the interest rate of a savings account is not the only factor you should consider when deciding on a savings account for your small business, calculating what a savings account rate will earn can give you the data you need to choose the right business savings account.
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