This article is for educational purposes and does not constitute legal, employment, or tax advice. For specific advice applicable to your business, please contact a professional.
Annual percentage yield, or APY, is one of the top factors business owners use when deciding to open a savings account. According to a survey Square commissioned from Harris Insights & Analytics, 63% of small business owners open a savings account when they start their business. Understanding APY can help you make a more informed decision as you grow your business.
What is APY?
APY is the annual percentage yield of a savings account — in other words, it is the interest you earn on a bank account in a year. APY is usually associated with savings accounts, and the higher the yield, the more you will earn on your money in the account over time. This is why a high-yield business savings account is considered a positive attribute if you’re opening an account. According to the FDIC, the national average interest rate on savings accounts is 0.05% as of January 2021.
Digging a bit deeper on how to think about yield, asking “what does this yield?” can also mean “what does this generate?” Similarly, yield in finance terms refers to the earnings generated over a time period on an investment (commonly expressed as a percentage).
APY vs. APR
APY and annual percentage rate (APR) are often mistaken for one another, as both are used to calculate money earned (i.e., interest earned on investing money) or money owed (i.e., what it cost to borrow that money) like loans or credit cards.
Unlike APY, APR is a common term on credit cards or loans that represents the annual rate of interest paid. There are several types of APRs, such as:
- Introductory APR (credit cards sometimes offer intro periods that have low APRs)
- Purchase APR (rate of interest the credit card company charges on purchases made with the card)
- Cash advance APR (when you withdraw cash from your credit card’s line of credit)
- Balance transfer APR and penalty APR (APR after you miss a payment or pay late).
When calculating APY and APR, the biggest difference between the two is that APY takes into account compound interest while APR does not. Compound interest is the interest paid on a loan or deposit. The frequency with which interest is applied is taken into account when calculating APY. APR takes into account the total cost of borrowing, not just the interest.
APY = (1 + Period rate) # of periods -1
APR = (( Fees + Interest paid on the loan) 365)100 / Number of days in the loan term
|APY is commonly used for savings accounts, certificate of deposit (CD)s, individual retirement account (IRA)s||APR is commonly used for credit cards, loans, loan refinancing|
|Annual interest earned on account (what you earn)||Annual interest paid on loan (what you pay)|
|Does not include fees||Includes guarantee fees, monthly maintenance fees, origination fees, closing costs, and check processing fees|
|Takes into account compound interest||Does not take into account compound interest|
What can affect APY?
Interest rates on your savings account may change. The APY on a savings account can fluctuate based on the federal rate, meaning if the Federal Reserve raises interest rates then your account’s APY can go up. Conversely, if the Fed lowers rates, your account’s APY may go down. While APY doesn’t fluctuate often, economic headwinds (like those prompted by the COVID-19 pandemic or changes in central bank policy) could affect interest rates.
The Federal Reserve may raise or lower rates for different reasons. The federal funds rate is a monetary policy tool used so rates could be lowered to stimulate the economy as it encourages borrowing and investing. When there is too much growth or worry around inflation, the Fed may then raise rates.
Understanding how interest rates are calculated can help you better reach your business savings and growth goals. APY is just one factor in determining which business savings account you may want to consider as you start your business.
The data for this analysis includes Square sellers and non-sellers that were owners or co-owners of small businesses across the U.S. with a revenue of $30,000 to $2 million. This survey, commissioned by Square, was conducted by Harris Insights from May 14-21, 2020. The survey included businesses with a range of industries, location (urban, suburban, and rural), employee size (less than five and five more more) and business age (less than three years and three years or more).