When we think of finance – commercial or personal – the first thing that comes to mind is cost, of course. However, there are upfront fees, completion fees, payment frequencies, variable rates and payment periods to confuse us.
To solve this problem, financial gurus developed the concept of the APR – or annual percentage rate. The concept was first used to compare long-term mortgages and has remained a part of the lending world ever since.
How useful is it?
When comparing similar loans from different providers, having an APR is excellent! It turns all of the one-off fees, flat fees, interest rates and different payment frequencies into one annual cost; so choosing between mortgage providers becomes as easy as comparing hammers in a hardware store.
However, much like tools, loans have different purposes. Just because the screwdriver costs less, doesn’t mean you should choose it over a hammer if you need to knock in a nail. Similarly, comparing APRs is not always the best way to assess the relative value of loans to your business.
It can be helpful to pop on your marketing hat and try to measure the ROI (return on investment) of a loan. Most short-term loans have a purpose (marketing spend, stock purchase, new hire, etc…) that will generate a return. If you treat the cost of the loan as an investment, you can measure the ROI on your borrowed money and see what value, if any, your business will get from it.
For example, you’re looking to get in some stock for Christmas and you can buy 1000 plastic Santas in bulk at £10 000 (normally £15 000) and sell them for £20 000. You need a loan to get the deal, but will lose the discount price if it takes too long to fill out the paperwork and get approved. The bank loan is definitely cheaper in terms of APR, but what value would each loan add to your company?
Unsecured loan ROI:
Return = £20 000 – £10 000 = £10 000
Cost = £1 000 interest on loan
ROI = £9 000
Bank loan ROI
Return = £20 000 – £15 000 (non-discount price) = £5 000
Cost = £500 interest on loan
ROI = £4 500
So in this instance, you’d actually get a better overall return from the more expensive loan. Certainly, this will not always be the case; and nothing in this suggests discounting the cost/APR associated with the loan. Sometimes, though, it’s worth looking past the simple cost of an investment, and measuring the investment’s value to your business – whether that’s an employee, a hammer or a loan.
This was a guest post, brought to you by Fleximize.