Compound interest is the reason your small business should save more

23 Apr 2021

Burton Matthews

Business Cash Solutions Regional Head at Investec Bank

Business liquidity is king, especially in a time of crisis. But small business owners who take an uncompromising approach to their liquidity provisions do a disservice to their long-term sustainability and future growth potential.

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While the Covid-19 economic crunch has placed unprecedented financial pressure on small- and medium-sized enterprises (SME) by straining already limited resources amid lower revenue and rising expenses, business owners should not neglect contributing to savings accounts. 
 
But in a market where margins are tight and liquidity is mission-critical, saving can prove challenging, especially for small businesses that relied on credit to get them through the crisis. 
 
While paying down debt should remain a key objective, it is equally important to focus on investing a portion of monthly profits into a suitable savings account or cash investment. In doing so, businesses stand to benefit from the power of compound interest, as the interest earned is reinvested to earn additional interest. 
 
Creating sound financial habits and a savings culture paves the way to greater resilience and a securer future for SMEs, which account for 98% of all formal business in the country and are crucial to South Africa's economic revival and longer-term growth and prosperity.
 
Investing money with financial institutions also creates a bigger pool of capital to deploy into the economy to stimulate growth. 
 
Based on an SME's risk profile, most small businesses require some form of lower-risk, secure investment to create greater security with a financial safety net. However, savings savviness that exploits compound interest creates additional opportunities for profit growth when applied intelligently.  
 
Numerous savings account options exist and there is no one-size-fits-all option for SMEs. The right savings strategy for your business should earn the best interest to grow your hard-earned money, while providing sufficient liquidity to meet short-term needs and day-to-day operational requirements or respond to a financial shock. 
 
In this regard, it pays to know the difference between fixed, notice and prime-linked accounts, with an understanding about the differences between nominal interest rates, annual effective rates or yield rates to select the most appropriate options.
 
With so many variables to consider, it is best to partner with a trusted and experienced financial services provider that understands your business to construct an individualised savings portfolio based your unique financial requirements.
 
A prudent approach could entail investing a portion of earnings in a savings account that secures the principal investment but lets you access the earned interest for working capital. Additional allocations to a savings account that benefits from the power of compounding will help to grow your capital over time.
 
Selecting the right combination could mean the difference between a business that struggles with cash flow constraints from month to month, and a thriving business that continues to grow unencumbered by financial stress for a more prosperous and sustainable future.
 
This article originally appeared in Business Brief.
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