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At first glance, it may seem like the lesser 2% interest rate is the way to go.  But a little more analysis of the numbers will reveal the truth.

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I sometimes have business owners ask me to compare the following options against say a 5% line of credit:

*Offering customers a 2% discount rate if they paid instantly

*Factoring receivables at a 2% factor rate

*Automatically charging a customer’s credit card for instant payment (assume credit card fees are 2%)

At first glance, it may seem like the lesser 2% interest rate is the way to go.  But a little more analysis of the numbers will reveal the truth.

Let’s Dig Deeper

The line of credit is stated at an annual interest rate.  So if you had a $100,000 line of credit outstanding the entire year, you would pay $5,000 in interest in a given year.

Assuming your customers normally pay invoices in 30 days, you must multiply the discount (or factoring rate, or credit card fee %) by 12 (roughly 360 days in a year / 30 days normal collection time) to get to the true apples to apples annual interest rate.  If you have $100,000 in monthly sales and give customers a 2% discount to pay instantly, that is $2,000 every single month, or $24,000 for the year.

What would you rather do?  Pay $5,000 in annual interest or reduce your annual sales by $24,000?  Hopefully you said $5,000 in interest.

On the other hand, if you have a vendor that is offering you discounts to pay early, you may want to use your line of credit to do so.  If you reverse the example above, and you were purchasing $100,000 per month, you could reduce your annual purchase expense by $24,000 by paying early.  In such a case it would be worth it to take on a $100,000 line of credit, and the $5,000 annual interest.

For more helpful tips, check out this blog from your CFO for hire.

http://blog.barbacfo.com/our-blog/5-things-you-should-know-when-reading-your-small-businesss-balance-sheet

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