How do interest rates affect businesses?

How do interest rates affect businesses?

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The rate of interest that is due for a given period, proportional to or depending upon the amount loaned or borrowed is referred to as the interest rate. Interest rates vary depending upon the type of loan, the amount borrowed, the willingness of the giver, and so on.

The interest rate charged on the amount given as a loan is the profit of the lender. The interest rate is charged annually on usual basis. Any person or organization who is lending money or giving a loan can charge an interest rate.

For example, banks charge interest rates on the various kinds of loans they offer to their customers, such as Home Loans, Car Loans, Education Loans, etc.

Apart from this, sometimes, people take loans from their friends and family members as well. This is primarily done because such loans are flexible, the borrower can return the money at his convenience with ease and requires almost no paperwork.

In India, money lenders have always existed. Before Banks came up, money lenders, usually people of rich upper-class families, practiced money lending as a profession. They lent money to small businessmen, farmers, and peasants, and charged interests as their profit.

How do interest rates affect businesses?

Loans are important for businesses. They can help a person set up his business, fill the gap of suddenly arising needs of funds, etc. Despite serving such important functions, businessmen try to avoid taking loans, mainly because of the business loan interest rates. Let us find out how the interest rates affect businesses.

1. Prime rates- 

Prime rate is the lowest business loan interest rate, at which commercial banks lend money. The increase in interest rates is directly proportional to the increase in prime rates. Increased rates of interest mean businessmen will avoid taking loans because it will take them longer to repay which means having to pay more. In such cases, loans start to feel like a burden, and not a convenient option.

2. Low income- 

Increased rates of interest mean that a considerable portion of the business revenue will go into repaying the loan. As a result of this, the businessman’s income will be reduced. Small businesses mainly operate to sustain and fill their fundamental needs. 

Their aim is not to earn crores and live an extravagant life. Low income earning directly affects their quality of life, leading to them having to compromise on necessities of life such as schooling, business expansion, etc.

3. Cash flow- 

Interest rates directly affect the cash flow in the local market. Small businesses still depend heavily on cash for day-to-day business operations. Increased or high rates of interest force them to keep most of what is earned to repay the loan.

As a result, they are left with no money to buy raw materials or stock, spend on marketing and advertising, hire more staff to reduce workload and improve efficiency, etc. This makes small businesses suffer and when small businesses suffer, the economy suffers too.

4. Hindrance in employment generation- 

Small businesses play a crucial role in generating employment for the local people. High-interest rates force businessmen to use most of their earnings for repayment.

As a result, they try to reduce the number of staff employed and cut other “extra expenses” as much as possible. Due to lower incomes and savings, business expansion is not possible either. Many businessmen are forced to shut their businesses. it hinders employment generation.

5. Demotivates potential Entrepreneurs- 

Many people who lack funds explore loans as a funding option. High-interest rates demotivate them from starting a business because they feel repayment of loans would be burdensome. Any business needs time to pick up the pace and start running smoothly. Till then, businessmen find it difficult to pay instalments. 

Interest rates can be a determining factor for the functioning of business units, especially small businesses. Increased interest rates are harmful to businesses therefore they must be kept under check.

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