The Little Loan Calculator That Could
A loan calculator solves for the missing variable in a loan equation. To see, for example, whether your company can afford to borrow $50,000 to expand, enter the loan amount ($50,000), interest rate (8%), and number of payback periods (60) and it calculates the monthly payment ($1,014). Can your company support another thousand dollars in debt service each month?
This information helps you plan cash flow - maybe your company would be better off borrowing only $40,000 and reducing the monthly payment to $811, saving $200 per month. You can supply any three of the variables and it will calculate the fourth. If you approach your banker with these numbers in hand, you’ll demonstrate that you’re in control of your company’s finances.
Be an educated consumer too, when it comes to buying equipment. We’ve heard clients say they leased equipment at a good rate when in fact they were misled into a very expensive financing contract. A loan calculator lets you run scenarios like this one: Say an equipment dealer offers you a deal to lease $25,000 worth of equipment for five years at $700 per month with a $1 buyout option at the end of the lease. Sounds good at first glance. But look deeper and here’s what you’ll find.
Using this calculator, you plug in $25,000, 60 months, $700/month payment, and find out the dealer is charging you almost 23% annual interest. That’s very expensive money in today’s credit environment. This technique is called backing into the interest rate.
Finally, use the loan calculator to keep your books straight. The loan calculator generates a schedule of principal vs. interest paid each month. On a typical fixed term loan, part of each month’s payment goes to principal (P) and part to interest (I). Over time, each month you pay more P and less I. Your bookkeeper needs to know how to allocate each payment so the company’s financial statements correctly state both interest expense and the principal balance of the loan.
This might seem like a minor bookkeeping detail, but consider the advantages of doing it right:
- You save money on tax return preparation fees because your CPA doesn’t have to clean up your books.
- A savvy bookkeeper can use the P vs. I schedule to improve your company’s current ratio by separating the current vs. long-term interest of the loan. A higher current ratio can make your company more “bankable” and at a lower interest rate.
- Bankers immediately spot bad bookkeeping, so an accurate set of books inspires confidence and removes one more obstacle from their saying “yes” to your loan.
For more information on the topics above, check out CCH Owner’s Toolkit. Type keywords, “term loan”, “lease vs. buy” and “current ratio” into their search window.
