If your small business has ever taken out a loan from a bank, the loan will typically be considered an installment loan. These types of business loans are typically paid back with equal payments on a semi-annual or annual basis. As such, the process of making payments on a business loans is called loan amortization.
Small business owners typically pay a fixed amount of principal plus interest on business loans. The debt is considered amortized when it is paid in equal installments over the life or term of the loan. Specifically, the principal is the same amount for each payment, but the interest rate fluctuates.
As more payments are made on the loan, the interest paid with each payment gets smaller, and more of the payment is allocated to the principal amount. An amortization schedule breaks down these factors in a chart that shows change over time with the specific amounts owed for each payment of the business loan.
Generally, amortization schedules are broken down into six columns.
- The first column is the year of the outstanding loan. If your business takes out a 5 year loan, there will be 5 years listed on the first column.
- The second column lists the beginning balance of the loan for each respective year. The beginning balance decreases each year by the amount of principal paid on the loan. As the principal is typically paid in equal installments, the beginning balance amount will be reduced by the same amount each year.
- The third column of an amortization schedule shows the total payment due for that respective year. The total amount is calculated by adding the interest and principal payments. For example, if you owe $3000 in principal and $240 in interest, your total payment would be $3240.
- The fourth column indicates the amount of interest to be paid for each respective year. Interest payments are calculated by multiplying the beginning balance by the agreed upon interest rate. For example, If you have a beginning balance of $15,000 and agreed to 8% interest, your interest payment would be $1200 ($15,000 x 0.08 = $1200).
- The fifth column shows the principal paid for each respective year. As principal payments are the same for each year of the business loan, the amount shown in this column will likely be the same for each year.
- Finally, the sixth column shows the ending balance at the end of each respective year. The ending balance is calculated by subtracting the principal paid from the beginning balance (Beginning Balance – Principal Paid). For example, if your business took out a $15,000 loan and the principal owed each year was $3000, your ending balance for year 1 would be $12,000 ($15,000 – $3000 = $12,000).
Shown below is an example of an amortization schedule for a $15,000 small business loan over 5 years at 8%.
|YEAR||BEGINNING BALANCE||TOTAL PAYMENT||INTEREST PAID||PRINCIPAL PAID||ENDING BALANCE|