How to Calculate the Cost of a Business Loan

Comparing the costs of a short-term loan to a long-term loan or a merchant cash advance to a line of credit or term loan can be challenging because different lenders can express their costs differently—making it a challenge to make an apples-to-apples comparison. With that in mind, there are five metrics that can help you calculate the cost of a business loan, which will make it easier for you to compare different financing options.

Because there is no one-size-fits-all way to describe every potential financing option available, here are five metrics you need to know:

1. Annualized Percentage Rate (APR)

The APR metric is a good way to compare loans with similar terms. It was introduced to help consumers make decisions about mortgages, auto loans, credit cards, and other consumer credit. Commercial lending, small business lending, is a little different. Because of the different ways businesses access funding, APR is one of the metrics you might compare, but it certainly isn’t the only metric.

APR is not the interest rate on a loan or used to calculate the total dollar cost of any financing, but is rather an annualized percentage rate that expresses the interest rate along with any fees associated with any small business financing.

2. Total Cost of Capital (TCC)

This metric will include all interest and any other fees that are a condition of receiving capital. The Total Cost of Capital metric discloses the total dollar cost of the financing option, a crucial source of information for a small business borrowing for a use case that includes a defined ROI.

3. The Average Monthly Payment Obligation

Not to be confused with “monthly payment” the Average Monthly Payment Obligation metric identifies the average monthly cash flow impact of repaying the financing option being considered, regardless of whether the periodic payment is daily, weekly or monthly. The average monthly payment obligation provides a common benchmark for evaluating monthly cost.

4. Cents on the Dollar

The Cents on the Dollar metric identifies the amount of interest (or loan fees, as applicable) paid for every dollar borrowed. This metric is exclusive of all other fees to allow for comparison with other common pricing metrics in commercial finance, including the factor rate, simple interest, and total interest percentage.

5. Prepayment Conditions

You should also be asking about whether or not there will be additional fees or charges for prepayment and what they may be. It also identifies if prepayment will result in any reduction in interest or applicable loan fees. Asking this will make any applicable prepayment policy readily transparent.

Transparency into these metrics will help you make an informed decision based on your use case and the costs associated with borrowing.

Different Use Cases Could Require Different Financing

Although you don’t need to become a small business financing expert to find the right loan for your business, if you arm yourself with these metrics, it will be easier to determine which type of financing will best meet your business need and will help you understand any potential ROI of any financing you may be considering.