A business has both income and debts, usually reflected on its balance sheet. Debts, also known as liabilities, can either be interest-bearing, which means they accrue interest that your business must then pay, or noninterest-bearing, which means they don't. Your debts can include interest-bearing loans and corporate bonds, but those will likely make up only a portion of your business's liabilities.
What Is Interest-Bearing Debt?
Whether it's personal or for your business, debt is money you owe to someone else. There are some debts that have no interest, such as employee pay and office space leases. You may choose to separate those on the balance sheet from interest-bearing expenses in order to determine how much you're losing each month on pure interest.
Business interest expense refers to the cost of interest that's charged to a business based on debts it has accrued. In some cases, that interest may be tax-deductible, as long as the money was used to purchase an asset related specifically to the business. On the balance sheet, you'll also see interest-earning assets, which refers to the money a business earns interest on.
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Calculating Interest-Bearing Debt
Interest-bearing debt is an important part of any business's balance since it helps you get a better picture of its debt-to-capital ratio. You can usually find a business's interest expense on its balance sheet, but if you don't have the balance sheet, or it isn't listed, you can calculate it. You'll need to know the interest rate the business is paying on each debt, and then you can multiply that rate by the amount of the related debt.
Sometimes you know the amount of a business's interest-bearing debt, but you don't know the rate it's paying on that debt. There's a good reason for that. Interest rates aren't always listed on the balance sheet. To calculate the interest rate on a debt, gather the expense, the time period the expense covers and the principal balance of that debt and apply this formula: periodic interest rate = interest expense ÷ principal balance x 100.
Paying Off High-Interest Loans
If you're a business owner looking at your balance sheet, you may wonder how you can take action on those interest-bearing loans in order to reduce your expenses. As with personal debt, business debt can cut into your ability to make progress. Your debt-to-capital ratio may also come into play if you look for investors or try to land big clients.
Landing on solid financial funding quickly can be easier if you first concentrate on paying down your interest-bearing debt. Not only can you take that liability off your balance sheet, but you'll save some of that money you're spending on interest every year. Take a look at your debts and choose those that charge the most in interest. Once you've paid those off, you can turn your attention toward noninterest-bearing loans.
Debt Payoffs and Credit Ratings
There's a natural concern that paying off your debts can hurt your credit score. A young business will need to start building a decent credit score now for eventually taking out a loan. Whether you're using your personal credit or you'll be building it for your business, paying off an interest-bearing loan can hurt your credit score, at least briefly.
However, in many cases, you'll find your debt-to-capital ratio is just as important, if not more so, than the number that creditors get when they pull your credit report. The reason you might see a drop in your score after paying off your interest-bearing debt is that your score is based on a variety of factors, including your credit utilization. Perhaps most notable, though, is the fact that paying off your credit may not bump your credit score up immediately but over time, it will benefit your business, especially when it comes to that all-important balance sheet.