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Everything You Need to Know About Calculating Cost of Debt

When you’re on the path to becoming a business owner, it’s easy to get overwhelmed with the flood of financial information you receive and research. You might have heard terms like cash flow, APR and cost of debt. But what does it all mean? How much do you really need to know to run a successful business? How do you ensure your business’ future is secure? The following information should help provide some clarity on one of the most important topics: calculating the cost of debt.

What is the Cost of Debt?

At one point or another, every business owner is faced with the issue of cash flow – or the lack thereof. Without sufficient capital, your business will find tasks like covering payroll, purchasing equipment and increasing inventory difficult. Covering the many costs of growth and expansion will feel impossible. To fuel your plans, you may need to seek capital elsewhere. This is where understanding how to calculate the cost of debt is important.

When a business owner takes out a loan, their main concern is securing enough working capital to grow their business and maintain cash flow. As a result, the cost of debt is often overlooked. In short, the cost of debt is the interest expense you pay on any and all loans your business takes out. If your business ends up with more than one loan, you will need to add up the interest rate for each to find your business’ cost for the debt.

The Cost of Debt Formula

Keep in mind there is more than one way to calculate your cost of debt; it will depend on whether you want to see it pre-tax or post-tax. To determine your cost of debt:

  • Add up all your loans, balances on credit cards, and any other financing tools
  • Calculate the interest rate expense for each for the year, and then add them up
  • Divide your total interest by your total debt to find your cost of debt

Now, if you want to know how much you’re paying in interest use this simple formula: Total interest/total debt = cost of debt.

On the other hand, if you would like to find out your cost of debt after taxes, use the complex formula: effective interest rate* (1 – tax rate).

Lowering Your Cost of Debt

Are you concerned with the result? Essentially, your cost of debt tells you whether you’re spending too much on financing if you’ve spread yourself too thin. If you are worried about your cost of the debt, the answer is to choose your financing carefully. Too many business owners put themselves in a tough situation because they jump at the chance to secure financing for their immediate needs without first considering the long-term consequences.

The best business loans are those that offer low rates, fast cash, and flexibility. If your credit score is low or you have suffered from bankruptcy in the past or you operate within a “high risk” industry, you will have to really do your research. Despite what you might have been told, there are still options available to you; you simply need to seek out a high-risk specialist.

Where to Secure Flexible Merchant Funding

Our experts at First American Merchant can help your business secure funding in as little as 24 hours. Our solutions are fast, simple, and hassle-free. As a high-risk specialist, we work with a long list of industries other providers consider “too risky” and turn away. We offer a wide variety of services and solutions tailored to meet your unique needs.