Simple Interest Formula is a mathematical method to calculate the interest paid or interest received at a certain rate against a specific amount of capital borrowed or deposit for a specified interval of time, as a result of a financial transaction.
As we know, the amount of money would increase by a certain amount with the passage of time. But, It must be kept is mind simple interest is always calculated against the initial investment.I = Prt
Where I = Simple Interest, P = Principal amount invested/borrowed, r = rate of interest, and t = time after which interest rate is applicable.
We often hear about the term interest in our routine life while making different financial transactions. These transactions vary from depositing the capital in your saving account to borrowing money from the same bank for investment in your business idea.
The term interest essentially refers to cost of borrowing or benefit of depositing money to any bank or during any other transaction. They are different types of interest and formulas associated to calculate it. However, today we are going to explain the Simple Interest Formula.
It is worth knowing that the concept of Time Value of Money, which states that value of financial assets or money, varies with the passage of time. This change in the value of financial assets or money happens due to various financial markets factors like inflation and depreciation of value of money. In most cases, it is a convention to assume that value of an asset would decrease over the period of time. So, in order to cater the estimated decrease in worth of money the concept of interest rate has been introduced.
Note: It must be bore in mind that Simple Interest Formula does not essentially guarantee that amount being received or paid is in accordance with the decrease or increase in local currency. This method just only ensures the receiving and payment of specific amount of capital as a result of a transaction.
Uses of Simple Interest Formula
Simple Interest Formula finds its regular use in our day to day life, and some of its very common usages are listed below:
- As obvious as it can get, banks use this method of interest rate calculation extensively. One common example is of car loan, where a certain portion of monthly instalment is used in repaying lone and other portion is used in payment of the interest.
- Departmental stores often offer their customers to buy items on based on Simple Interest. Suppose if a customer buys a $600 fridge on 6% interest and agrees to pay the amount in a year, then he/she is supposed to pay an instalment of $53 monthly. So, in total customers pay $36 extra over a $600 in the bid of 6% interest.
Alex deposited $40,000 in a bank 10 years ago. Now, he wants to start a business, and he wants to withdraw the amount from the bank. Calculate the amount received by him from the bank along with his initial investment.Solution
- Principal Amount = P = $ 40,000
- Rate of interest = r = 6 % = 0.06
- Number of years = t = 10
So, Alex will receive $ 24,000 in interest alongside his initial investment of 40,000.
Our Simple Interest formula explained earlier is perfect to use in all the situations; however, there is another formula which is widely used to calculate the total amount returned after simple interest is applied to an initial investment for certain periods of time. The formula is given below:A = P( 1 + rt )
Where A = The total amount of principal plus interest. The above formula is very common, but if you want to keep the things plain and simple then it is advisable to calculate Simple Interest first and later on add it to the principal amount to obtain the total amount received after accumulation of the simple interest.