Do you know the true cost of your asset-based loan?

Asset-based lines of credit are a popular finance tool most businesses use to unlock capital held in inventory. Wide utilization, however, does not imply that everyone understands their true cost. When figuring the total cost of money, there is way more to consider than just the upfront interest rate for your loan. Below are just a few items to consider when comparing financing options.

• Advance Rate. Not all lines of credit are equal and certainly not when it comes to advance rates – the percent of inventory value the bank will loan on. Low advance rates prevent you from realizing the full potential of the inventory value, meaning a sizable amount of cash is still tied up in the product. Any way you look at it, that’s a cost – and quite often, a major one. Obviously, the closer you can get to a 100 percent advance rate, the better.

• Focus on fees.  Doing business with banks brings a variety of fees, such as loan origination fees, unused line of credit fees, service fees, fees applied for flexing the line up or down, and termination fees. When all those charges are added up, a 3.00 percent rate can quickly rise by ¾ of a percent or higher.

• The value of equity. If companies are going to fall down anywhere in the finance process, it is in undervaluing their equity. In order to accurately compare finance packages, companies cannot discount this cash outlay. They must determine an ROI that they could expect had those dollars been used for additional production or investment. After all, nobody hands out cash without an expectation of a return. This number absolutely must be figured into that total cost of money. And once it is tallied, that initial upfront interest rate undoubtedly will rise.

So as you shop for asset-based financing, the goal should be to maximize the advance rate, reduce or eliminate fees, and minimize the cost of equity through a low or no down payment.

So what does all this mean? Just how much do these costs impact the interest rate

Consider a $15 million line at 2.75 percent. We’ve already established that fees, alone, can drive costs up by $317,953.

If you look at the equity required to support the difference between the advance rate and the value of the product, you will be required to come up with roughly $4.3 million in cash. If you assess a value of 10 percent to the cost of this required equity, that adds an additional $431,250 to the cost of the line of credit.

That brings the total cost of debt and equity to $749,203 and shifts the previously low 2.75 percent interest rate to 4.99 percent.