Management – The High Cost of Low Interest Rates

Nov
08

Management – The High Cost of Low Interest Rates

MANAGEMENT

The High Cost of Low Interest Rates

Even when interest rates are at historic lows, interest costs can be significant for businesses and owner-managers.

The Business

The significant rise in the cost of equipment, vehicles, real estate, and inventory has prompted many businesses to increase business debt. Low interest rates, combined with the ability to obtain larger loans with extended payment terms, have allowed businesses to operate in a “business as usual” mode with less consideration for the actual cost of borrowing.

To give some idea of the effect of even low interest rates on an owner-managed business, the following key elements of most businesses have been put forward as an example of the effect of interest costs on a business. The effect of domestic borrowing has been added to show the full impact of current interest rates on the owner-manager. Since lending rates vary widely depending on a variety of factors such as risk, item to be funded and the term, and are usually negotiated, the interest rates used below have been chosen at random from Internet sources; calculations are approximate and for illustrative purposes only. All loans have been made effective June 1, 2017.

 

  • Commercial mortgage: $600,000 over 25 years at 3%
  • Two work vehicles: $120,000 financed over five years at 6%
  • Equipment loan: $200,000 financed over five years at 5%
  • Operating line of credit: $50,000 at 3% a year
  • Credit card debt: $10,000 at 15% a year on the outstanding balance

Commercial Mortgage

  • Commercial mortgage amount: $600,000
  • Interest for first year: $17,776
  • Interest paid over first five years: $83,748
  • Interest paid over the 25 years (300 months) of payment: $253,580
  • Total commercial mortgage cost: $853,580

A sobering reality is that, when interest costs are factored in, the $600,000 building ends up costing $853,580. Assuming the interest is a deductible business expense, and assuming a 17% corporate tax rate, total interest would be reduced by $43,109, thus reducing the overall cost of purchasing to $810,471.

Work Vehicles

  • Total purchase price of two vehicles: $120,000
  • Interest for first year: $6,623
  • Interest for five years: $19,196
  • Total vehicle cost: $139,196

Equipment Loan

  • Loan amount: $200,000
  • Interest for first year: $9,179
  • Interest for five years: $26,455
  • Total loan cost: $226,455

Line of Credit

  • Annual outstanding balance: $50,000
  • Interest for one year: $1,500
  • Interest for five years: $7,500

Credit Cards

  • Average annual outstanding balance: $10,000
  • Interest for one year: $1,500
  • Interest for five years: $7,500

Over five years, the total interest cost to your business is $144,399. Even at a 17% corporate tax rate and a corresponding $24,548 reduction over five years, the cost of borrowing is still $119,851.

The hard truth is that interest costs even in times of low interest rates have a very negative impact on the bottom line.

 

NEED HELP? CALL HURON PARTNERS AT 905-848-8830 OR EMAIL AT INFO@HURONPARTNERSLLP.COM

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