Understanding the Cost of Business Funding

By vklejmont | Jun 18, 2018 | Uncategorized |

Financing can be a scary proposition for a business owner. Every day business owners make challenging decisions, and making the wrong decision can be harmful. BizLender wants to help you understand the cost of funding and navigate your business through the business funding process.

There are different types of financing such as cash advances, factoring, and loans. Securing business funding depends on many circumstances, ranging from:

  1. Time in Business
  2. The Owner (s) Credit Score
  3. Business Income
  4. Funding Amount Requested
  5. Timing of funding
  6. Term of the loan
  7. Lender
  8. Loan Type

Recognizing how to overcome those circumstances to reduce the cost of your funding and securing a funding product that sufficiently meets your needs and timing can be complicated and challenging.

BizLender has built connections, software, and customer support teams that are second to none in the industry to help you every step of the way. Yet, it is still essential that you know and understand the cost of your business funding needs.

Business funding products can be defined in many ways, and BizLender wants to help you understand the cost of the various funding types.

  • Nominal Interest Rate refers to the advertised or declared interest rate on the loan, without taking into account any fees or compounding of interest. A loan with a 12-month term at a 24% nominal rate compounded monthly would charge a 2% interest on each month's loan balance.
  • Effective APRrecognizes the effect of compounding but also the fees associated with the loan or funding. The total of the costs and fees are then annualized. A $3,000, 6-month loan with a 12% nominal interest rate and a $100 origination fee would have a 35.2% effective annualized percentage rate (APR).
  • Factor Rate/Buy Back Rateis the multiplier for the total payback on the loan. A 22% nominal interest rate on a 6-month loan (allowing no other costs) will present a 1.22-factor rate. The factor rate does not reflect the impact of compounding and implies by the end of the funding term all the costs and fees have been paid. The factor rate is typically used in cash advances and factoring.
  • Total Payback combines both the cost/interest and fees of the funding, including the principal balance. Total payback is the total amount to be paid back over the funding term.
  • Payment Schedule is the frequency the borrower is required to remit payments, including principal and interest or fees, whether it be automatic ACH withdrawals or manual payments on a daily, weekly, or monthly basis.
  • Funding Term is the period of time the borrower has to pay back the sum of the funding or loan. Multiple funders will permit borrowers to renew the accounts when the total paid back reaches greater than 50%.

Understanding the correlation between these various expressions is paramount to avoiding making an erroneous business funding decision. Illustrated below is an example of how APR can mislead a company to understand the actual cost of capital.

The Effective APR on the Interest-Based Funding is much lower than that of the Factor-Based Funding. In many financial products, APR is used to normalize the cost of funds to enable borrowers to analyze and compare separate financing options. Yet, as seen in the graphic above, if given just Loan Amount, APR, Term, and Payment Amount as data points, the APR would mask the actual structure of a loan. The business owner would most likely be cautious of taking the Factor-Based funding even though the cost is almost $6,000 less than the Interest-Based funding. In theory, APR is supposed to let the borrower compare multiple financing options, yet, when all the financing products are not interest-based, APR distorts the actual cost.

BizLender hopes with some key information between various business financing products; you can address your business's need for capital, knowing the right questions to ask.
We suggest requesting information on the Term, Fees, Payback, and Payments.

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