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Avoiding Opportunity Cost

Share current LOB: commercial-corporate-banking

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:

  • Company A's largest volume raw material supplier has a short-term offer with substantial discounts because their inventory levels are too high. For the buyer, the chance to increase their short-term profit margin is significant, but the order will require more cash (in 30 days) than the buyer normally has on hand.
  • A high-margin, regular customer reaches out to Company B with great news of a larger than normal order with quick turnaround demands. The news is exciting for Company B's revenue goals, but squeezes its cash flow because it will need to front the expenses of manufacturing the product.
  • A prospect that Company C has 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. Company C is thrilled to have the chance to finally begin a relationship with them, but is nervous whether or not their cash flow can absorb the overtime that will hit payroll.
  • Company D's largest customer is struggling with cash flow due to a one-time write-off. Company D doesn’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 a 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 they may need to secure access to addition funds

A line of credit is a flexible credit tool that can be used in a number of different ways to fund business needs. Giving a business flexibility with operating capital is the primary benefit of a line of credit.  Should a company’s receivables slow from 60 days to 90, they can access their line of credit to cover cash flow until receivables catch up. Should their sales have an unexpected spike or a planned seasonal cycle, a line of credit can help them 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 it’s needed, in the amount needed
    • Pre-authorization to borrow funds, up to a specific amount
    • Quick and easy access, via check writing or online cash transfers into a company’s 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 an authorized limit after minimum balances are paid

Opportunity Cost: Understand the Alternatives

Opportunity cost thinking requires understanding 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 used 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 actually using 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. business tax advisor can be consulted for more information.
  • 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 easy and affordable access to cash when you needed.  

    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 a business healthy and growing. Ask a SunTrust banker how we help grow and strengthen businesses today.

    Disclaimers

    This content 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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