![]() Example 2Ī company has taken out a loan worth $90,000 at an annual rate of 10%. If you want to calculate the monthly charge, just divide the interest expense by 12. This means that at the end of the fiscal year the company has to pay $250 to cover their interest expense. To calculate the exact interest expense this company has to pay we apply the formula: Let’s say a company borrows $5,000 from the American National Bank, with an annual interest rate of 5%. Let’s check out a few examples to understand this formula better. Interest Expense = Debt Balance × Interest Rate How to Calculate Interest ExpenseĬalculating interest expense is very simple: Interest coverage ratio is calculated by dividing (earnings before interest and taxes) by (total outstanding interest expenses). A high interest coverage ratio, on the other hand, indicates that there’s enough revenue to cover loans properly. It’s important to calculate this rate before taking out a loan of any sort to make sure the business can afford to repay its debt.Ĭreditors and inventors are also interested in this ratio when deciding whether or not they’ll lend to a company.Ī low interest coverage ratio means that there’s a greater chance a business won’t be able to cover its debt. ![]() The interest coverage ratio measures the ability of a business to pay back its interest expense. To learn more about payables and how to record them as journal entries, head over to our accounts payable guide. Since it’s a liability, interest payable accounts are recorded on the balance sheet and are due by the end of the accounting year or operating cycle. Interest payable, on the other hand, is a current liability for the part of the loan that is currently due but not yet paid. It’s recorded as an expense in the income statement. Interest expense, as previously mentioned, is the money a business owes after taking out a loan. ![]() Difference Between Interest Expense and Interest PayableĪ term you might confuse with interest expense is interest payable. Interest rates are typically lower for these types of loans. Long-term debts, on the other hand, such as loans for mortgage or promissory notes, are paid off for periods longer than a year. For these types of debts, the interest rate is usually fixed at an average of 8-13%. Short-term debts are paid within 6 months to a year and include lines of credit, installment loans, or invoice financing. Interest expenses can be either short or long term. And if you’re using an online accounting system, the software can calculate this for you. In most cases, you won’t have to calculate the interest due yourself - financial institutions will send you a breakdown of the cash owed. The interest part of your debt is recognized as an interest expense in your business’ income statement. Automate Expenses with Accounting SoftwareĪny time you borrow money, whether from an individual, another business, or a bank, you’ll have to repay it with interest.In this guide, we will go through the different types of interest expenses, and the appropriate steps for calculating and recording them. Interest expense is an extra percentage you have to pay to your creditor as compensation for borrowing cash from them. Now, taking out a loan usually comes with an associated cost known in accounting as the interest expense. An undeniable fact of running a small business is that at some point the company will have to take out a loan to advance its operations.Īfter all, unless the owner is managing the business just for fun, they want to expand operations in the hopes of earning more money.
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