Basis points (BPS) explained: A quick guide for small businesses

Understanding financial jargon can be a headache, especially when you’re running a small business. But there’s one term you can’t afford to ignore—basis points (often abbreviated as BPS).

Whether you’re dealing with interest rates, loan agreements, or investment returns, basis points can significantly impact your bottom line.

In this article, we’ll give you all the information you need to know about what BPS are, why they matter, and how you can use this knowledge to make informed financial decisions.

What are basis points?

A BPS is a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One BPS equals 0.01%, so if you hear that an interest rate has increased by 100 BPS, it means the rate has gone up by 1%.

This small unit is especially useful when dealing with percentages less than 1%, where even tiny changes can have a significant impact.

For example, if a bank offers you a loan with an interest rate of 4.75%, and the rate increases by 25 BPS, the new rate will be 5%. It’s a straightforward concept, but one that can be confusing if you’re not familiar with the terminology.

Another example could involve currency exchange rates. Imagine you’re converting £100,000 to euros, and the exchange rate improves by 10 BPS.

While this might seem insignificant, when dealing with large sums, even a slight improvement in the rate can give you noticeable savings.

Why are basis points important?

Basis points are crucial in finance because they provide a clear and standardised way to discuss changes in rates and yields. In conversations where precision is key—such as when negotiating loans or discussing investment returns—using basis points can prevent misunderstandings.

In fact, a small miscommunication over a seemingly minor percentage could lead to significant financial discrepancies.

For small businesses, understanding basis points is particularly important in the following areas:

1. Interest rates: whether you’re borrowing money or earning interest on your savings, knowing how basis points work can help you better understand how even a small rate change can affect your finances. For instance, if your business loan rate increases by just 50 basis points, the extra cost over the term of the loan could add up to thousands of pounds. On the other hand, a reduction of 25 basis points on your savings account interest rate could mean a significant drop in your expected returns, especially if you’re relying on interest income to fund business operations.
   
2. Loan agreements: when discussing the terms of a loan with a lender, the interest rate is often quoted in basis points. This allows for a precise understanding of the cost of borrowing. For instance, if your lender offers a reduction of 15 basis points on a large loan, it’s really important to understand exactly how much money you’re saving. This knowledge can give you the confidence to negotiate better terms or compare offers from different lenders more effectively.
   
3. Investment yields: investors often use basis points to discuss returns on bonds and other fixed-income investments. Knowing how to interpret these figures can help you make smarter investment decisions. For example, if you’re comparing two bonds—one yielding 3.75% and another yielding 3.65%—the difference of 10 basis points might seem negligible at first glance. However, over the lifetime of the bond, this small difference could translate into a meaningful difference in income, especially for larger investments.
   

BPS meaning in finance

In finance, basis points are used to avoid ambiguity when discussing rates and percentages. If someone says “the interest rate increased by 0.5%,” it might not be immediately clear whether they mean 0.5 percentage points (which would be 50 basis points) or an increase of 0.5% of the original rate.

By using basis points, financial professionals can be clear and precise.

For example, an increase from 4% to 4.5% is an increase of 50 basis points, not 0.5 basis points. Understanding this distinction is key when dealing with financial contracts or investments.

It’s easy to see how confusion could arise if terms like “half a percent” are used instead of basis points—especially in many financial discussions where clarity is crucial.

In the world of derivatives and complex financial instruments, even a few basis points can mean the difference between profit and loss.

Traders and portfolio managers often make decisions based on minute changes in rates, so understanding the precise meaning of basis points is essential in these contexts.

How to calculate basis points

Calculating basis points is straightforward once you get the hang of it. Here’s a simple formula:

• 1 basis point = 0.01%
  
• 100 basis points = 1%
  

To calculate how many basis points a percentage represents, you multiply the percentage by 100. For example:

• 0.25% = 25 basis points
  
• 1.5% = 150 basis points
  

If you want to convert basis points back to a percentage, you divide by 100. So, if you have 75 basis points, divide by 100 to get 0.75%.

Let’s consider a real-life scenario. You’re a small business owner negotiating a loan of £200,000, and the interest rate is reduced by 30 basis points from 5.25% to 4.95%.

While 30 basis points might seem minor, over the course of a 10-year loan, this reduction could save you thousands of pounds in interest.

Common scenarios involving basis points

Let’s explore a few more examples where understanding basis points can be particularly useful:

1. Loan interest rates
   

Imagine you’re negotiating a business loan, and the lender offers an interest rate of 4.25%. After some discussion, they agree to lower it by 25 basis points. This means your new interest rate is 4%, potentially saving you a significant amount in interest payments over the life of the loan. The exact amount saved would depend on the loan size and term, but even a small reduction could improve your cash flow, freeing up funds for other business needs.

2. Credit card rates
   

Credit card companies often increase interest rates in small increments, like 50 or 100 basis points. Understanding this can help you make better decisions when choosing or managing a credit card. For example, if you’re considering a balance transfer to a card with a lower interest rate, knowing how to compare offers in basis points can help you avoid cards with hidden costs.

3. Investment returns
   

If you’re considering an investment in a bond offering a yield of 2.75%, and you learn that the yield has increased by 50 basis points, this means the new yield is 3.25%. Knowing this can help you decide whether the investment is right for you. Even a small increase in yield could significantly boost your returns over time, particularly in a low-interest-rate environment.

4. Currency exchanges
   

For businesses that deal with international clients or suppliers, currency exchange rates can have a big impact on profitability. Suppose you’re converting £500,000 to US dollars, and the exchange rate improves by 20 basis points. While 0.20% might not seem like much, it could mean a difference of hundreds of pounds in your favour. Understanding how to monitor and take advantage of such shifts can give your business a financial edge.

5. Interest rate hedging
   

If your business relies on borrowing or has large loans, you might consider hedging against interest rate increases. Understanding how hedging instruments like interest rate swaps work—often discussed in basis points—can help you manage your financial risks more effectively. For instance, if market analysts predict a rate hike of 75 basis points, you might decide to lock in a fixed rate now, protecting your business from higher costs in the future.

Final thoughts

Basis points might seem like a small detail, but they play a significant role in the financial world. By understanding what basis points are and how they work, you can make more informed decisions about loans, investments, and other financial matters.

Remember, even small changes in rates or yields can have a big impact on your business—so it pays to be precise.

Whether you’re negotiating a loan or evaluating an investment, knowing how to calculate and interpret basis points will give you a clearer picture of your financial situation.

Armed with this knowledge, you can make decisions that benefit your business in the long run.