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Avoiding Opportunity Cost

Share current LOB: CommercialCorporateInstitutional

Opportunity cost doesn’t appear on a company’s income statements or balance sheets, yet, missed opportunities can be significant drivers of whether or not yearend goals for growth, profit and cash flow are realized. Most of us think of opportunity cost as the expense of inaction or the economic cost of one alternative over another. Consider the following scenarios:

  • Your largest volume raw material supplier has a short-term offer with substantial discounts because her inventory levels are too high. For you, the chance to increase your short-term profit margin is significant, but the order will require more cash (in 30 days) than you normally have on hand.
  • A high-margin, regular customer reaches out with great news of a larger than normal order with quick turnaround demands. The news is exciting for your revenue goals, but squeezes your cash flow because you’ll need to front the expenses of manufacturing the product.
  • A prospect that you’ve been courting finally comes through with a larger-than-expected order. They’ve experienced a seasonal spike in their business and their usual suppliers can’t deliver. You are thrilled to have the chance to finally begin a relationship with them, but you’re nervous whether or not your cash flow can absorb the overtime that will hit payroll.
  • Your largest customer is struggling with cash flow due to a one-time write-off. You don’t want to damage your relationship with them, but their usual net 30 receivables are creeping to 60 days.

 

Most owners will agree that all of these situations carry opportunity costs for business – real costs that will impact net income. What most don’t realize is that there is a solution that is neither rare nor complicated:  a line of credit. A line of credit is an affordable, flexible tool that helps business owners keep their options open for opportunities (or unexpected situations).

A Line of Credit provides flexible access to cash allowing your business to
  • Finance ongoing working capital when receivables are slow/late
  • Leverage unexpected opportunities
  • Purchase inventory when offered at special pricing
  • Balance out cyclical business fluctuations or seasonal reductions in sales/income
  • Pay bills early and receive discounts
  • Prepare for business downturns where you may need to secure access to addition funds to tide you through

A line of credit is a flexible credit tool that can be used in a number of different ways to fund your business needs. Giving your business flexibility with operating capital is the primary benefit of a line of credit.  Should your receivables slow from 60 days to 90, you can access your line of credit to cover cash flow until receivables catch up. Should your sales have an unexpected spike or a planned seasonal cycle, a line of credit can help you even out the swings in product expenses.

Distinguishing features of a line of credit

Compared to other credit vehicles, a line of credit offers much more flexibility. A line of credit provides:

  • Cash – when you need it, in the amount you need
    • Pre-authorization to borrow funds, up to a specific amount
    • Quick and easy access, via check writing or online cash transfers into your business checking account
  • Flexible repayment schedules
    • Interest is accrued only on the outstanding balance
    • Payments are typically monthly
    • Interest rates are generally lower than most other credit products but are variable, and may fluctuate monthly. 
  • A revolving cash fund account where funds automatically regenerate up to your authorized limit after minimum balances are paid

 

Opportunity Cost: Understand your Alternatives

Opportunity cost thinking requires that you understand how a line of credit stacks up versus the alternatives:

  • Inaction: As presented in the scenarios, the opportunity cost of inaction ranges from missed revenue or profit, fees for slow payables, lost customers, customer dissatisfaction or personal infusions of cash into the business.
  • Term loan: Payments for a term loan are calculated on the total amount of the loan (not just the amount you use at any given time). Also, the approval process for a term loan is typically too slow for these types of opportunities.
  • Credit cards:  Terms are unattractive with high interest rates and rigid monthly repayment schedules.

 

Aspects to consider

A line of credit can be a very helpful tool; however, there are a few dynamics to consider when investigating a line of credit.

  • Fees. There are usually up-front fees when applying for a line of credit, as well as fees each time the business draws from the line.  These fees must be taken into account when calculating the overall benefit of the line of credit.
  • Repayment schedules. Schedules fluctuate based on the total amount drawn from the line of credit and the variable interest rate, so it is important to understand how to budget for repayment when you actually use the line.
  • Tax Issues. The interest paid on a line of credit does not automatically qualify as a tax deduction.  Supporting documentation is typically needed to prove that the funds from a line of credit were used for business expenses before interest can be deducted. Consult your business tax advisor for more information.
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    A Line of Credit is a Flexible Opportunity Tool

    SunTrust understands the opportunity costs of business decisions, and offers short and long-term capital solutions that can help you seize opportunities as well as weather unexpected cash needs. A line of credit is both an opportunity tool and a safety net – providing you easy and affordable access to cash when you need it.  

    It is not a long term funding strategy, and not necessarily for large purchases, but when used strategically for short-term capital needs, a line of credit may be the key to keeping your business healthy and growing. Ask your SunTrust banker how we can help you grow and strengthen your business today.

    This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

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