Small Business Finance by Rick Nason PhD CFA && Dan Nordqvist CPA CMA MBA MSc

Author:Rick Nason, PhD, CFA && Dan Nordqvist, CPA, CMA, MBA, MSc
Language: eng
Format: epub
Publisher: Business Expert Press
Published: 2020-01-15T00:00:00+00:00

Cost

Cost of financing is an obvious consideration. All else being equal, the lower the cost of financing, the better. Later in this chapter we will discuss the WACC. The WACC is exactly what its name says, it is the weighted cost of financing of all the sources of financing for the firm. It is important for two reasons. The first is that the lower the cost of financing, the greater the net residual benefits will be to the shareholders or owners of the business. The second benefit is that the lower the WACC, the greater the value of the firm will be, all else being equal.

The cost of the financing can sometimes be tricky to calculate. For instance, what is the cost of the owner’s sweat equity? It is certainly not zero, for if the owner were not putting time into building the business, they could probably earn an income working for someone else. The time spent building the business through sweat equity could productively be spent earning wages. The cost of sweat equity must account for not only the forgone wages, but also for the stress and worry that the business proprietor takes upon themselves. Counteracting this might be the joy of working for one’s self rather than working for another person or a corporation.

Even the cost of a bank loan with a stated interest rate can be tricky to evaluate as covenants on the loan or restrictions, such as mandatory balances, can be a source of hidden fees and costs. These fees should definitely be included when considering the cost of the capital.

Furthermore, the tax implications of various types of financing need to be taken into account. While one should never choose a form of financing simply for the tax implications, the reality is that certain forms of financing, such as debt, have beneficial tax effects that can significantly lower the tax bill.

A more holistic view of cost of financing is required. The cost of financing needs to be taken into account with the overall objectives of the business. For instance, if a major objective is to grow rapidly, then growing financing needs are likely and thus flexibility to scale the financing may be a more critical factor than cost. While lower cost in financing is preferred, that is only true when all else is equal, and when it comes to sources of financing, the reality is that all else being equal is generally not the case when it comes to cost.

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