1.10.17 – Calculating The Real Cost Of Business Lending – Part 1
Finding out the real cost of financing your business is a crucial part of any plan to expand, boost profits or just improve your cash flow. Unfortunately, this basic task is not always easy.
Getting a real cost before agreeing a business loan means digging into the small print and getting your calculator out. However, other forms of lending such as invoice discounting are actually clearer about their costs.
APR works for business loans
When a bank or alternative lender is trying to persuade your business to choose them, they have ways of promising rates that look very reasonable. Remember that the lender charges various fees for setting up and providing a business loan, and these should be incorporated into calculations of the real cost of lending.
The best way to compare loans is therefore by looking at the annualised percentage rate (APR), which includes all of these fees to give a more realistic idea of what the loan actually costs. Even then, it can be hard to know exactly what you are getting. Until very recently Australian banks were almost universally operating a system that gave them sweeping powers to close business overdrafts and withdraw business loans without notice.
Thanks to the recent work of the Australian Small Business and Family Enterprise Ombudsman, the banks have agreed to change their ways. But they retain their ability to vary contracts under certain circumstances.
SMEs can also seek an business loan from an alternative lender that are called “unsecured Loans” although many of them are secured by a personal guarantee. But because they carry out little due diligence, the APR can be very high – up to 72% from some lenders.
Debtor finance is the real alternative
The so-called alternative lenders aren’t really so different from the banks. On the other hand, business have the option of using their unpaid invoices to raise money, and this is a very different proposition from a technical point of view.
Invoice discounting, and other forms of cashflow finance such as factoring, are explained on tim’s website. But how can you compare the cost of raising money this way with other forms of business finance?
Often many accountants and business advisers try to compare invoice financing directly with business loans by simply annualising the discount rate – effectively, the fee that a company like tim. deducts for advancing cash against your invoice.
But using receivables in this way is actually the sale of a company asset at a discount to the face value of an invoice or pool of invoices under a facility provided by tim. A discount rate of 2% over 30 days cannot be accurately described as a 24% APR, any more than a business offering a 5% discount for early payment of a claim would be thought of as offering credit at 60% per annum.
Factoring falls somewhere in the middle, but with flexible invoice discounting you retain total control and know exactly what you’re getting. Effectively, it’s a fixed and known fee with the finance company even arranging to collect its own repayment.
Another important feature, is that the discount fee is only payable once the debtor has paid the invoice. So, your business is advanced funds against the face value of invoices under a facility provided by tim. and fees are only paid 30, 60, 90 or 120 days later. No regular payments to service, funds in your account immediately and an ability to use all or nothing of the facility. Thus providing absolute flexibility and reduced costs.
This, however, is just the start. Canny businesses can get their money for nothing, and even make a profit on their invoice discounting. Find out how in the next edition…
To be continued..