It's amazing how many finance providers that aren't transparent about the full cost of commercial finance. It doesn't matter which product you choose for your business - a term loan, invoice finance or an overdraft. It doesn't matter where you borrow from - a bank or an alternative finance provider. The cost of credit is a combination of both the interest and the fees you pay!
To make sure you're getting the best deal, you need to compare the total cost, and keep a watchful eye for all the parts that will make up your total cost of credit.
What are the components of the total cost of credit?
Interest, which is a function of three elements:
- Quantity - how much you borrow
- Price - at what interest rate
- Time - for how long
AND Fees, which come in lots of different flavours:
- Application fee
- Arrangement fee
- Service fee
- Usage fee
- Repayment fee
- Early repayment fee
- Legal fee
- Exit fee
APR? What's that? Who needs it?
Unfortunately, business credit isn't covered by the same regulation as consumer credit. This means that commercial finance providers aren't required to disclose an annual percentage rate (APR), which would otherwise help you compare the cost of different products and providers.
But just because providers aren't required to provide an APR, it doesn't stop you asking them for this! If they won't or can't provide you with a clear number, you have to ask yourself if they have something to hide. If they tell you it's too complex and not useful to assess the credit product in those terms - walk away
DIY APR calculation
If you want to calculate the approximate APR yourself, there is a simple rule of thumb you can use.
Add up all the interest and all the fees you pay over one year, divide this by the average amount borrowed across the year. This will give you an approximate annual percentage rate that you can use for comparison purposes.
We collect pricing data and have created a cost of commercial finance comparison tool to help businesses estimate the APR and Total Cost of Credit for different popular products. We detail our calculations and assumptions so that you can follow (and challenge!) our maths.
In our next post, we will unmask the common tricks used by finance providers to hide the total cost of business credit, and provide you with tips to help you uncover and navigate these while evaluating your options. This will make sure you will get the best deal on finance for your business.
(A version of this article was also featured on the ICAEW Business Advice Service)