Most business owners usually need financial assistance, such as a loan, within the first couple of years of starting their business. However, before you take out a loan, it’s essential to calculate your debt cost. The cost of debt refers to the amount of interest that you must pay on top of the principal loan amount. In this blog post, we’ll explain the cost of debt and how you can calculate it for your business.
What Is Cost of Debt?
The cost of debt is simply the rate at which a person or business must repay borrowed funds. It includes any interest payments and other fees associated with borrowing from a lender. When taking out a loan, lenders may offer different types of loans with different rates and terms, which can sometimes make it difficult to determine your total debt cost.
How to Calculate Your Cost of Debt
Calculating your cost of debt is easy if you know where to look and what information to use. Here are step-by-step instructions
on how you can calculate your cost of debt:
STEP 1: GATHER RELEVANT INFORMATION
This includes a list of the outstanding debts your business owes, APRs your business owes on each of its debts, and other fees associated with the loan, such as origination fees, interest rate repayment period, or closing costs.
STEP 2: CALCULATE YOUR PRE-TAX COST OF DEBT
Add up all of the interest payments over the life of the loan by multiplying each payment by its corresponding interest rate. Make sure to include any upfront interest payments in addition to regular monthly payments throughout the life of the loan. You can determine your business’s pre-tax debt cost with the following formula: Add your total interest expenses for the year and divide the total by your total business debts.
Total Annual Interest Expense / Total Debts = Pre-Tax Cost of Debt
Then, plug the above figures into the cost of debt formula:
Total Annual Interest Expense ($10,500) / Total Debts ($200,000) = Pre-Tax Cost of Debt (0.0525 or 5.25%)
NOTE: Remember that different types of loans may have different fees or associated terms, so research before committing to any particular lender or loan product.
Debt has become an unavoidable part of doing business today. But, understanding how the amount you take out will impact your long-term cash flow can ensure you make informed decisions while deciding whether or not to take out a loan for your business needs. By following these steps, calculating your cost of debt should be straightforward and can save you the
Get fast access to extra capital for your business whenever you need it.
Approximately 17 percent of U.S. small and medium-sized companies have between 100,000 and 250,000 in outstanding debt. Fortunately, with the help of a knowledgeable lender, you can determine the right debt based on your business expenses and debt history that aligns with your business needs. We offer a wide range of lending options so that you can choose the best rates and loan terms to fuel business growth responsibly. Contact Proto Financial today to learn more about our lending options.