Capital: What is your actual cost?

What do you actually pay to use someone else's capital? To calculate your cost is simple: payoff amount minus original proceeds is your cost. When business owners ask me for a rate quote many times they confuse rate with cost, they aren't the same because time (how long your're paying that rate) is critical. Which costs more: $100k @ 25% for 6 months or 4% for 5 years?

What is the most important commodity in your business? I mean, what is the thing you really can't have enough of to grow your business? It could be micro chips, key personnel or materials/energy but most likely all those things tie directly into the one commodity which controls all the others: Capital.

Right now, capital is actually one of the most affordable commodities of all. Massive price increases combined with supply chain disruptions have all made most critical commodities like Oil (plastics!) and food staples increase in price much more than the cost of capital.

That is, the cost of capital is the same as last year but everything you buy with it has now gone to the moon.

Those who used borrowed capital to purchase materials or hire key personnel as early as 3 months ago have already covered their cost of capital by avoiding the increased cost they would have to pay now, assuming they could even get supplied!

Here is how the 12 Federal Reserve governors view our current business climate:

The Fed’s Beige Book is a summary of economic conditions in the 12 Federal Reserve Districts.

  • Boston: “Inability to get supplies and to hire workers.”
  • New York: “Businesses reporting widespread labor shortages.”
  • Philadelphia: “Labor shortages and supply chain disruptions continued apace.”
  • Cleveland: “Staff levels increased modestly amid intense labor shortages.”
  • Richmond: “Many firms faced shortages and higher costs for labor and non-labor inputs.”
  • Atlanta: “Wage pressures more widespread.”
  • Chicago: “Wages and prices increased strongly”
  • St. Louis: “Contacts continued to report labor and material shortages.”
  • Minneapolis: “Hiring demand outstriped labor response by a wide margin.”
  • Kansas City: “Wages grew at a robust pace.”
  • Dallas: “Wage and price growth remained elevated amid widespread labor and supply chain shortages.”
  • San Francisco: “Hiring activity intensified further, as did upward pressures on wages and inflation.”

Now that the wheels have been set in motion price increases will beget new price increases and, until unemployment benefits stop for real there will be labor shortages and wage pressures.

If you look at capital as a commodity it's easy to understand that the cost of using someone else's money is just like any other cost of doing business you pay. It's also easy to see how using a commodity that costs "X" to use will pay for itself over time as long as prices of other commodities are going up.

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