Loan length, interest rate, payment amount and payment frequency all contribute to the total cost of a business loan. Setting up an amortization schedule can help you understand exactly how much interest expense your business will pay over the life of the loan. It's simplest to calculate an amortization table in a spreadsheet template or on a calculator. Either option allows you to change variables, such as interest rate or loan length, and understand their effect on interest income.
Before the Loan Starts
To set up an amortization schedule, create a chart with columns for the period, the payment, the payment interest portion, the payment principal portion and the remaining principal. The number of periods is based on the life of the loan and the frequency of payments. For example, if you take out a one-year loan with monthly payments, you'll have 12 periods and period zero. Period zero is easy to calculate. You haven't paid anything yet, so the remaining principal is the full balance of the loan.
The First Payment
In the first period you can begin to calculate the composition of the payment and the remaining principal. Say, for example, you take out a $10,000 loan at 5 percent interest with monthly payments of $856.07 for one year. The interest portion of the $856.07 payment is the remaining principal multiplied by the monthly interest rate. In this period, the monthly interest rate is 0.4167 percent and the interest portion is $41.76 (10,000*.004167). The remaining portion of $814.41 (856.07-41.76) is the principal portion of the payment. The principal balance is reduced by the total payment you made, so the new remaining balance is $9,185.59 (10,000-856.07).
Changes in Principal
You'll calculate period two in the same way that you calculated period one. However, because the remaining balance changes every period, the ratio of the interest part of the payment to the principal part will change. The interest portion of the payment will diminish over time as the remaining balance gets smaller. For example, the remaining balance at period two is $9,185.59. The interest portion of this payment is $38.27 (9,185.59*.004167). The principal portion goes up to $817.80 (856.07-38.27) and the remaining balance decreases to $8,367.79 (9,185.59-856.07).
By the time you get to period 12, the balance of the loan will be zero. Sum the "interest portion" figures from each period to determine the total interest expense your business will incur over the life of the loan. The dollar amount of the interest expense is important, but so is the length of time over which you pay it. As long as there's inflation, a dollar today is worth more than a dollar tomorrow and you should pay less interest on debts with shorter terms.
Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.