Borrowing With Increasing Rates---Does it still make sense?

Like many things in finance, the answer often begins with…it depends.

When money is cheap, many projects make sense to fund with a short-term loan, unless the margins are razor thin.?For example, let’s say that you plan to sell a large amount of goods (normal retail $100K) at a steep 20% discount to a customer.?The cost from your supplier is $65K and you don’t have the working capital to make this purchase.?You receive purchase order financing that has a dollar cost of $730 for 90 days.?In this example, the financing is a relatively insignificant portion of your overall costs and it makes sense to do the deal.

But what if rates doubled?? Given the insignificant nature of the financing costs, your financing still makes sense with a cost $1,460.

We often confuse the impact of interest rates on short-term debt with the impact that they have on long-term debt, like a mortgage.?This is because we all know how much a higher mortgage rate can drive the monthly payment on a thirty-year loan.?This isn’t the case, however, with short-term debt because the dollar cost is as much a function of “time” as it is of “rate.”

Now, don’t get me wrong, this doesn’t mean that you can’t get into trouble with high-interest working capital debt.?Here are two common mistakes that some business owners make:

Misuse of a Credit Line- These financial products are designed to provide you with funds when needed and are not intended to be permanent financing.?Let’s say that the summer months are slow and you need a credit line to get you through July and August.?If this is the case, you would then be wise to pay off what you borrowed in the Fall when things pick-up in the Fall.

The misuse of a credit line takes place when a business owner quickly draws the maximum amount available and then pays the minimum amount due every month.?By doing this, they’ve turned a short-term financial product into long-term financing and the higher interest rate will come back to haunt them.

Unhealthy MCA Borrowing- Much like my credit line example, you should only take out an MCA if you know that you have a stream of income coming your way to pay it off.?In this regard, using an MCA to fund materials for a big job might make sense, but it is almost always a mistake when you take out a second MCA before you even finish with your first, and then a second and third soon thereafter.?This unhealthy cycle of borrowing is a clear path to a very bad end.

So when you need some working capital, don’t let all the talk of rising interest rates scare you away.?You must always do the math---the numbers never lie.