If you're entering the world of finance or business, you may have heard the iconic quote from Albert Einstein: "Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." However, this article isn't about how wonderful interest is, but rather how it works and how it affects your business.
No matter what you're doing in terms of business finance, credit, borrowing, or anything else, when the government announces new interest rates, the economy will change.
Interest rates are part of the government's monetary policy to manage the economy. When you read the newspaper or news feed, you'll find out how important interest rates are, but you may not understand why. Let me quickly explain how money, or currency, is generated in the first place.
Normally, physical money (notes or coins) doesn't stay in large quantities with any person, business, or organization. It's held in the bank in the form of deposits. Next is the bank's business. The bank can make a profit by lending the money to individuals or businesses through any form of credit. But where does the lent money come from? Exactly, deposits! Let's move on to the next step. When an individual or business borrows money from the bank, what do they do with it? They buy products or services, right? And what do you do at the end of the day? You save that money on your desk/safe or deposit the money at the bank, or most businesses receive money via bank transfer. And the bank uses that money to lend to new customers again. So this is how currency is created! At the end of a certain period, the borrower needs to pay interest.
From the above, you can see the variable that I've been talking about, which is interest. Imagine what will happen when the government announces an increase in interest rates? People will borrow less money because the cost of borrowing has increased, right? And that's how interest rates affect the sales of your business. Even if your business sells products or services at a small price, customers may not need to borrow money from the bank because they have less money or what we call purchasing power to buy any product/service. Conversely, if the government announces a decrease in interest rates, your sales will also increase because customers have more purchasing power.
But it's just a short-term effect of changing interest rates. In the longer term, which may be twice a year to 10 years, the ability to pay debts will be a concern. Therefore, entrepreneurs need to learn more about economics to better understand what factors will affect their businesses in the future and what decisions they should make today to grow their businesses.
