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Opportunity Cost vs. Facility Cost

5 Sep 2019 10:29 AM -

Today, we highlight the importance of understanding the opportunity cost. Furthermore, we will discuss turning that knowledge into a tool that will benefit not only your clients, but also yourself across multiple areas of your business..

Opportunity Cost

How do we define opportunity cost? It's simple. When making decisions we might use a pros and cons list or think about risk versus reward. For a self employed client, it’s a similar process aimed to work out the return on investment (ROI) after they subtract the cost of funding. The amount that remains is what we refer to as the opportunity cost if you chose not to pursue or pursued an alternate opportunity. No doubt you’ve heard the expression “you have to spend money to make money”. If a client does this correctly it means a positive ROI. 

Facility Cost

When one of our small business clients makes a decision to accept a new client, or to purchase a larger amount of stock than usual because it’s currently being heavily discounted, they may not necessarily have the funds available to do so. This will result in enquiries into funding options. All of the costs associated with the potential facility, interest, establishment fee’s, service fee’s etc. will be added together to reach a total amount known as the cost of funding.

Impact On Facility Cost 

As we review the client's individual/business circumstances we look to align the needs of our client's product/policy type and lender partner's risk appetite. The risk drivers will be for example, available security, available income to service the new and existing facilities, the consistency of this income and the likelihood that it will remain the same moving forward. In short, the lenders are doing their own internal opportunity cost weighing up the potential risks versus security. They can then provide your client with pricing that reflects the risk, otherwise known as rate for risk.

High Risk Solutions

Up until very recently, there were a lack of funding options available to small business clients who didn’t have property security or equity available. Thankfully, over the past 12-18 months we have seen a dramatic increase in financiers who are entering this needed market. The challenge for our small business clients is attempting to navigate through these options to find the right solution for them. That’s where you, as a mortgage broker/finance professional come in!

The Problem

“Are you paying too much?” “For a rate review contact me today!” “Best rates, market leading!” In this industry, interest rates are one of the less complex ways of which to review loan options comparatively with your clients. It’s not using acronyms or finance jargon and therefore clients can easily understand that 4.5% is better than 5%. On the other hand, when using rate as the main driver to our conversations we often miss the other product features that may be important to the client and hence the opportunity cost. 

We often see this thought process take place when brokers, bankers, accountants etc. step in on behalf of their clients assuming the rates are too high and that the clients won’t want to proceed. What we know now is the only factor that’s worth considering is the opportunity cost. If that figure is positive then that’s the cost your clients will wear by not pursuing the opportunity. 

Example: Jess just started a business and she needs a $40,000 loan for a van. Given the shop hasn’t been trading a full year under current ownership, she is not eligible for traditional bank funding. She estimates it will increase profit by $60,000 per year after operating costs across the van’s 5 year lifetime. She qualified for one of our lenders start up policies with a rate of 19% over 12 months meaning the associated interest cost is $7600 plus associated fees of $1200. Moreover, this brings the total cost of funding to $8800 against the return on investment  of $291,200. Hence, the opportunity cost over the 5 years is $291,200.

Example: John the financial planner, bills his clients at $400 per hour. He decides to close his office one afternoon to paint his office himself. This will take him four hours and therefore effectively cost himself $1,600 in lost wages.
If he had done the simple equation to figure this out, he could have hired painters who would have charged only $1,000 for the same job. Bill’s opportunity cost is the difference, or $600.

As a business owner, we urge you to think about opportunity cost in relation to your own business. Firstly, start by working out what your time is worth, take your annual income and break it down to an hourly rate. Secondly, have a look at an average week and your time allocation for the various areas of your business. This is really useful as we often see business owners fall into the trap of thinking that by doing everything themselves that it will save them money. 

Happy to help.

If you are looking for a solution to assist your consumer and commercial clients with all asset, equipment and cash flow finance solutions - but don’t yet have the knowledge and can’t justify the high costs associated with multiple accreditations, specialist systems or a full time specialist on the payroll – then NLG Leasing is the right business partner for you. If you would like more assistance, please contact the NLG Leasing team on 1300 722 011 or email

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