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Financing Your Operating Cycle


John Harrington's headshotLast month we looked at how best to use a commercial line of credit. In that article, First Bank’s John Harrington, Western Region Senior Credit Analyst, showed us why using it to pay for working capital is the most efficient and easiest way to manage cash. This month, he provides a real world example of this strategy in action.

The ready objection to working capital financing is obvious: “But it’ll cost more interest! Why use debt to pay for things when cash is sitting in the bank account?” While true technically, there is an argument to be made that this structure is much easier to manage. But more importantly, the true value of working capital financing comes in the form of opportunity cost. By using cash to fund the operating cycle, companies are forced to pass on more valuable options to invest their cash into.

Here is a real world example

A business client has a $500,000 commercial line of credit (LOC) that is used for working capital purposes. The balance rises when the company is busy, and reduces, sometimes to $0, when it is slow. The loan had a high balance of $424,000 and also spent almost a month at $0. Over the course of the year, the average balance was $218,000. At a 5% interest rate, this results in total interest expense for the year of $10,900.

In this situation, working capital financing pulled hundreds of thousands of dollars out of the operating cycle and onto the balance sheet. Now, say the company in our example need to buy $350,000 in equipment. They have two options: the cash that was available thanks to the LOC or yet another loan. A $350,000 equipment loan at 4.5% interest, less than the rate on the LOC, would have accrued $14,443.62 in interest in the first year alone, resulting in higher interest expense of more than $3,500.

In this comparison, it’s easy to see that using the LOC for working capital frees up a greater percentage of cash. In turn, the cash can be invested more wisely in things like higher ROI assets without the need to get additional financing. The ability to use your cash like this often provides sufficient interest savings to cover the cost of the LOC balances and ultimately allows for greater strategic freedom.

Ready to explore your business loan options or additional avenues for business savings? Your local business banker is ready to help you find the best solution and tailor it to the needs of your company. Stop by or give them a call today.

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