How A Loan Amortization Schedule Can Benefit Small Business Owners

As a small business owner, securing a loan can be crucial for fueling growth. But before you celebrate getting approved for a loan, it’s crucial to understand the exact terms of your debt and the details of your loan repayment plan. This is why it’s essential to create a loan amortization schedule.

To amortize a loan simply means paying it down, a small amount at a time. A loan amortization schedule is a table outlining the details of each loan payment over the life of the loan. It breaks down how each payment is allocated between interest and principal. And it helps you:

• Predict monthly payments: Know how much you owe each month over the loan repayment timeline.
• Plan cash flow: Accurately forecast your financial obligations, making budgeting and managing expenses easier.
• Make informed decisions: Understanding the amount of interest you’ll pay over the life of the loan helps you choose the right borrowing option.

Creating a loan amortization schedule doesn’t require dozens of spreadsheets and complex calculations. Here is how to create an easy-to-understand amortization schedule:

1. Gather loan information – Collect the essential information about your loan, including the loan’s start date, amount, interest rate and term (number of years).
2. Choose a loan amortization method – There are two primary methods for loan amortization. Both straight-line amortization and declining-balance amortization lead to paying off your loan. However, they differ in how the principal and interest are distributed throughout the repayment period (see next section for a detailed explanation.)
3. Use a loan amortization calculator – To simplify the process, leverage online loan amortization calculators or spreadsheet software. These tools automate the calculations, saving you time and minimizing the risk of errors.
4. Input loan details – Enter the loan details you gathered in Step 1 into the calculator or spreadsheet.
5. Review the amortization schedule – The tool then generates a detailed amortization schedule. Review the schedule to understand how each payment is divided between principal and interest.

As noted above, the two primary amortization methods differ in how the principal and interest are repaid.

In the straight-line amortization method, your monthly payments remain constant throughout the loan term. Each payment consists of fixed portions of the principal and interest. As you make payments, the proportion of your payment towards the principal increases while the interest portion slowly decreases.

This method offers:

• Predictability: Consistent monthly payments make budgeting and cash flow management easier.
• Transparency: Each payment clearly shows how much goes toward principal and interest.
• Lower initial payments: Paying more interest upfront can mean lower initial payments.

In the declining-balance amortization method, your monthly payments start off higher, gradually decreasing over time. The interest is calculated on the remaining loan balance each month, so a larger portion of your initial payments go toward interest and a smaller part toward principal.

This method offers:

• Faster principal payoff: Paying more of the principal earlier shortens the effective loan term and reduces the total interest paid.
• Tax benefits: Early principal payments can offer tax advantages depending on your tax situation.

Choosing the right method

The best method for your small business depends on several factors, including:

• Budgeting needs: Predictable payments of straight-line might be easier to manage.
• Financial goals: If paying off the loan quickly is crucial, the declining-balance method may be better.
• Tax implications: Consult your accountant to understand the potential benefits of each method.

These are the critical parts of a loan amortization schedule

• Payment Number: Each row of the amortization schedule represents a specific payment number, helping you track your progress throughout the repayment period.
• Payment date: Knowing the date each payment is due is crucial for ensuring on-time payment
• Payment amount: How much money you must pay each period, including principal and interest
• Remaining balance: This shows the remaining loan balance after each payment. As you make payments, the balance decreases.

Following the loan repayment schedule makes good financial sense, of course. Making extra payments is even more advantageous. Here are some key benefits:

• Save money: Any extra money paid toward the principal lowers the loan balance more quickly, leading to interest reduction over time and lessening the overall cost of borrowing.
• Build equity: For loans associated with assets, such as mortgages, reducing the principal builds equity in the asset. This particularly impacts real estate, where increased equity can lead to additional financial benefits, such as the ability to leverage the equity for future financing or a higher resale value.
• Improve creditworthiness: Reducing the principal balance demonstrates financial responsibility, positively affecting your creditworthiness. Making timely payments and reducing debt helps build a positive credit history, which is essential for obtaining favorable terms on future loans.
• Financial flexibility: Lowering the principal balance frees up financial resources that would have gone toward interest payments. This allows borrowers to allocate funds to other business needs, investments or emergency expenses.
• Reduce interest rates: Reducing the principal balance mitigates the impact of interest rate fluctuations for variable-rate loans. As the outstanding debt decreases, interest rate changes have a smaller effect on the overall cost of the loan.

Understanding your loan amortization schedule helps you better manage your finances, plan for the future, and optimize your loan repayment strategy. More specifically:

• Early repayment strategies: Understanding the schedule allows you to explore options for early repayment, potentially saving on interest costs.
• Budgeting: An amortization schedule helps you budget, ensuring you have the funds available to make the loan payments.
• Interest cost: Seeing the breakdown of interest payments helps you understand the overall cost of borrowing and make informed financial decisions going forward.

A loan amortization schedule is a valuable tool for small business owners, helping you manage your finances effectively, plan for the future and optimize your loan repayment strategy.

For help understanding your small business loan options, contact a SCORE mentor for support.

This article originally appeared on Score.