How EMI is calculated
EMI = P × r × (1 + r)n ÷ ((1 + r)n − 1)
P = loan amount · r = monthly interest rate (annual rate ÷ 12 ÷ 100) · n = number of monthly instalments
Example: a ₹25 lakh machinery loan at 10.5% a year for 5 years. r = 10.5 ÷ 12 ÷ 100 = 0.00875 and n = 60. The EMI comes to about ₹53,735, and total interest over the loan is about ₹7.24 lakh.
How each EMI splits between interest and principal
Every EMI is the same amount, but its make-up changes. Early on, most of it is interest, because interest is charged on the full outstanding balance. As the balance falls, more of each EMI goes to principal. The schedule above shows this year by year.
That is why a part-prepayment early in the loan saves far more interest than the same prepayment near the end.
EMIs and business cash flow
- Match the tenure to the asset. A machine that earns for 10 years can be financed over 5 to 7. Financing working capital over long tenures hides a cash problem.
- Check the EMI against monthly cash flow, not just profit. A profitable business can still struggle with fixed monthly repayments. See working capital.
- Interest is a business expense; principal repayment is not. Your CA will show them separately in the accounts and the cash flow statement.