When you’re making capital investment purchases, you’ll also use business finance to weigh the pros and cons of different repayment options. Let’s say you have a choice between a lower-interest loan with high monthly payment and a quick repayment period versus a higher-interest option with lower monthly payments over a longer period of time. Of course, a lower-interest option is the best option, provided you have the cash flow to pay for it.
But if your cash flow is tight and the equipment upgrade will save you enough money to cover some added interest, you may actually decide that the option with higher interest and a lower monthly payment is better. Lower payments help cash flow, and good cash flow puts you in a position to take advantage of opportunities.
There is no set, reliable formula for evaluating all the costs and benefits of a long-term financing option. However, if you consider all the ways that a purchase will affect your income and expenses, you’ll probably make a better decision than if you focus on the interest rate alone.
Another variable that will affect the long-term costs and benefits of a purchase is the value of the money you spend and the way it changes due to inflation. When you make a loan payment in the future, you’ll use capital that is worth less than the capital you borrowed because inflation decreases the value of money over time.
Accountants and finance professionals use a formula called “return on investment” to calculate all of the quantifiable benefits that an investment will bring in over time and then compare these benefits with the total cost