Financial modelling terms explained

# Interest Expense

Interest expense is the total cost of interest paid to external parties on the debt of an entity. It is one of the costs that have to be subtracted from revenue to determine net income.

## What Is Interest Expense?

Interest expense is the cost of borrowing money. It is expressed as a percentage of the amount borrowed, and is paid periodically, usually monthly. The interest expense calculation takes into account the amount of time the money is borrowed for, the interest rate, and the principal amount.

## How Do You Calculate Interest Expense?

There are a few different ways to calculate interest expense. One way is to use the effective interest rate. To find the effective interest rate, divide the annual interest rate by the number of periods in a year. Another way to calculate interest expense is to use the amortization method. To use the amortization method, you need to know the amount of the loan, the interest rate, and the number of periods in a year. The amortization method calculates the interest expense for each period and then subtracts it from the principal.

## What Is the Difference Between a Simple Interest Loan and an Amortized Loan?

Simple interest loans are paid back in fixed installments, where each installment consists of both interest and principal. The principal portion of each installment does not change, meaning that the total amount of interest paid over the life of the loan remains the same. Amortized loans, on the other hand, involve gradually decreasing principal payments over the life of the loan. This means that the total amount of interest paid over the life of the loan is not fixed, and may be more or less than with a simple interest loan.

## When Should You Use Simple Interest, and When Should You Use Amortized Loans?

There are a few key factors to consider when deciding whether to use simple interest or amortized loans:

-The interest rate

-The loan amount

-The number of payments

If the interest rate is high and the loan amount is small, then simple interest is the better option. This is because with a small loan amount, the interest payments will be large in comparison to the loan amount itself, so it makes more sense to just calculate the interest on a per-period basis.

If the interest rate is low and the loan amount is large, then amortized loans are the better option. This is because with a large loan amount, the total interest payments will be small in comparison to the loan amount itself. It makes more sense to spread those payments out over the life of the loan.

## What's the Difference Between the Interest Rate and the Annual Percentage Rate?

The interest rate is the rate of return that a borrower earns on a loan, while the annual percentage rate (APR) is the rate of interest that a borrower pays on a loan, including both the interest rate and any associated fees. The APR is typically higher than the interest rate, because it includes all of the costs of taking out a loan.

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