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When running a small business, every penny counts. Understanding how your savings work can help you make the most of your hard-earned money. One term you might come across is AER. Here’s a simple guide to help you understand it and use it to your advantage.
Key takeaways
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AER (Annual Equivalent Rate) shows how much interest you'll earn on your savings over a year, factoring in compounding interest payments.
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The gross interest rate is the basic rate before compounding. AER takes compounding into account and shows the true growth potential.
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A higher AER means a greater return on your business savings. Choosing an account with a good AER helps grow your savings faster.
How does AER work?
AER (Annual Equivalent Rate) shows how much interest you’ll earn on a savings account over a year, as a percentage. It factors in compounding, which means earning interest on your interest. This makes AER a great way to see the true growth potential of your savings.
It’s important to know that AER is often variable, meaning the rate can change over time due to market conditions or bank policies. Always check if the AER is fixed or variable when evaluating accounts.
For example, if you maintain a balance of £1,000 in a savings account with a 3% AER, you’ll know exactly how much you’ll have after a year, including all the compound interest earned. With 3% AER, your balance would grow to £1,030 after one year.
AER vs. gross interest rate
Here’s a quick comparison of the two terms you’ll see most often when looking at business savings accounts:
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Gross interest rate: Basic rate of interest without compounding.
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AER: Total interest earned including compounding effects.
To put it into context, let’s compare two accounts with the same gross interest rate of 4% but different compounding frequencies:
|
Account Type |
Interest Rate |
Payment Frequency |
AER |
Total After 1 Year |
|
Account A |
4% |
Monthly |
4.07% |
£104,070 |
|
Account B |
4% |
Yearly |
4.00% |
£104,000 |
Even though both accounts offer the same gross interest rate (4%), the total amount of interest you’ll earn will be different because of how often interest is compounded.
This shows how compounding can make a difference over time, even with the same gross interest rate. AER helps you make fair comparisons and choose the best account for your business.
How to calculate AER
The formula for AER takes the interest rate and how often interest is paid into account. Here’s how it works:
AER = (1 + interest rate ÷ times interest is paid in a year) ^ times paid - 1
If that formula looks scary, don’t worry. Banks and financial institutions usually provide the AER upfront, so you won’t have to crunch the numbers yourself.
How to use AER to save smartly
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Compare accounts easily: AER gives a standard way to evaluate savings options, so you can spot the best deal.
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Boost your cash reserves: Even small differences in AER can add up, especially over time or with larger balances.
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Understand compounding: Frequent interest payments mean higher returns, thanks to compounding.
The bottom line
AER is a simple but powerful tool to help you grow your business savings. By understanding and comparing AER rates, you can:
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Maximise the interest you earn.
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Make informed decisions about where to save your money.
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Ensure your cash reserves are working as hard as you do.
By choosing accounts with competitive AERs, you’re not just letting your money sit idle; you’re actively putting it to work for your business. Whether you’re saving for future investments, creating a buffer for unexpected expenses, or planning for growth, a strong AER can make all the difference. With a little research and a focus on the right metrics, you can ensure your financial resources are being used to their fullest potential.
Remember, your savings are a foundation for your business’s future. By understanding AER and making informed financial decisions, you’re taking a big step toward long-term stability and success.
This does not constitute financial advice. Please consult an accountant or financial advisor if you would like more information.
