Understanding the cost of an asset based loan when contemplating the business loan options available in the marketplace is critical to making an informed decision. Most all business owners need capital from time to time to meet the needs of a growing business. They self-fund operations for as long as they can and if they hit their growth goals, they often require additional capital to get there.
The problem is that fast growing companies are often not profitable and have little in the way of retained earnings. This due to the fact that every dollar going in to the business is going back out to meet working capital needs. This is where asset based business loans are a dependable source of capital.
However, the analysis is much different. Your typical business loan is an SBA loan with a 10-year amortization and fixed monthly payments. This type of term loan is great for fixed costs and long term assets such as equipment, real estate, etc. But what if your needs are revolving in nature?
For example, our typical client comes to us because he has a big order that they can not fulfill on their own. Here’s a breakdown of a common scenario we secure funding for:
- $1,000,000 loan request to cover the cost of goods and pay suppliers
- The company has a 30% margin or can make $1,300,000 upon the sale to their customer (if they can get a hold of $1,000,000 to fulfill the order!)
- They have a verifiable purchase order from their credit-worthy customer
- They are expecting the total business cycle to be 60 days from the time of the order to shipment to the customer to being paid by the customer
- Cost of the revolving credit (in this case purchase order financing, a form of asset based lending) is 2% of the loan amount per month
- Simple equation: $1,000,000 x 4% equals $40,000 (cost of capital), $1,000,000 carrying a 30% margin equals $300,000 profit
- Net profit on the transaction after the funding cost is $300,000 minus $40,000 or $260,000.
The question becomes, would you spend $40,000 to make $260,000? The answer for almost everyone is yes! As seen, figuring the cost of an asset based loan is much different than a typical business loan. The review consists mainly of looking at the return on capital versus “interest rate” which so many people are obsessed with.
We have actually had clients say that this cost of capital is “too expensive” on an annualized basis. If the business loan revolves every 60 days, the cost is $40,000 multiplied by 6 (60 days divided in to 360 days for the year) the cost is $240,000 in annualized capital cost. However, we need to remember the profit the company stands to make with this type of asset based loan. The net profit per turn was $260,000. If we multiply that by 6 we get $1,560,000 income on an annualized basis.
So, the question becomes, would you spend $240,000 to make $1,560,000? The answer is a resounding, YES, of course!
If your business could grow using a creative asset based business loan, we would like to hear from you and discuss the options.
To your success!
Patrick Zazueta | Huntington Coast Capital, Inc.