Interest

Introduction

Interest is the charge a person is required to pay on the money borrowed. Interest is payable on debentures and bonds and other debt securities or monies borrowed.

Interest may be paid as simple interest or as compound interest. Simple interest is paid at a fixed rate per annum. Compounding allows for the calculation of interest on the principal and the accumulated interest.

Understanding Interest

Interest also denotes ownership in a corporation—for example, an equity interest in a corporation or LLP.

Borrowing of money offers ease of funds for working capital requirements, business expansion and asset purchases. In the case of borrowings, the interest payments are tax-deductible from the income. The interest payments offer leverage for the business to generate more cash flows.

Factors to Consider

1. The calculation is based on the face value of the instrument.
2. The interest cost is benchmarked against the opportunity cost of the funds.
3. The interest is allowed as a deduction for the person making the payment.
4. The interest is taxable as income of the lender or the holder of the debt securities.
5. The interest payment may be subject to a tax deduction at source.
6. The interest rate depends on external factors such as external benchmark rate, prime lending rates, rate of inflation, the time period for which the money is lent and ease of repayment of the loan.
7. The interest rate also depends on the risk of repayment of the loan.
8. In India, borrowings are available from the unorganised sector as well. For example, rural India relies on unorganised money lenders for funding requirements for agriculture and small businesses. 9. The organised sector consists of banks and financial institutions. The organised sector has its reach both in rural India as well in urban and semi-urban India.
9. The developmental activities and economic development largely rely on availability of money through organised banking and financial institutions.