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Stephen G.
Stephen G., Sr Financial Expert
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Accounting and Finance Question: Theoretical question about

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Accounting and Finance Question:

Theoretical question about a business loan:

PayPal Working Capital Loan (New program offered)- $953.00 fee for $20,000.00 loan (That's it. No other fees, payments, or penalties). Repaid at 10% of daily gross sales/cash flow processed through PayPal until paid in full (only paid on days where there are sales). At current monthly sales of approx. $50,000.00/month it is approx. 4 months to repayment. $953.00 is 4.8% of $20,000.00. Does that make the effective annual interest 14.4% ( 4 months at 4.8% x3) or is it something else? Please explain in detail...

Stephen G. :

Hello, my name isXXXXX & I'll be helping you today. My goal is to give you a complete & accurate answer that you can understand.

Stephen G. :

It is something else.

Stephen G. :

You would have to factor in the actual amount of the loan outstanding at the end of each month.

Stephen G. :

So with your figures, you would have 20K for 1 month, 15K for 2 months, etc. until the loan was paid off

Stephen G. :

So you don't have the whole 20K for 4 months.

Customer:

Can you scale the interest for me?

Stephen G. :

Obviously, the effective interest rate is higher as the charge doesn't change but the outstanding loan is reduced by 10% of your sales each month.

Customer:

We could easily make more than $953.00 off of the $20,000.00 by purchasing select inventory.

Stephen G. :

Scale? What do you mean?

Customer:

Probably 30-40% of $20,000.00\

Customer:

But is it a decent price for the money in your opinion?

Stephen G. :

Well, I'm sure but that wasn't your question.

Stephen G. :

Not unless you have no other conventional borrowing ability.

Customer:

Well, it doesn't sound like there is an easy answer to the interest question. Can you tell me the effective annual rate on our money?

Customer:

I need to know if we are getting decent value.

Stephen G. :

Can't you get a working capital loan with the inventory pledged as security?

Stephen G. :

There must be a time limit on the payback or an agreement to process all of your sales through Paypal or something?

Customer:

Probably. But that would be conventional with a lot of strings. We are pre-approved for the Working Capital- no strings or hoops. I really don't need the loan, just toying with possibilities...

Customer:

No time limit....they base it off of previous history.

Customer:

But it would take about 4 months.

Stephen G. :

Well, it isn't a good deal compared to regular financing; the longer you kept the Paypal loan outstanding, the lower your effective interest rate would be, using the terms you describe.

Customer:

We have a long history of $50,000+/month through Paypal. They just require that we don't divert payment processing from normal...

Stephen G. :

The 953. is a one time charge?

Customer:

yes

Customer:

no other charges or fees

Customer:

of course their security

Customer:

is they can call the loan

Customer:

from your paypal account

Customer:

The advantage is instant funding with no further delays.

Customer:

The down side is it's expensive money compared to conventional.

Stephen G. :

Well the 4.8% is an annual rate, so your effective rate is much higher.

Customer:

But, no personal guarantee, etc.

Customer:

I see

Stephen G. :

It's just like a credit card

Customer:

Can you tell me what it calculates out to under the terms described?

Stephen G. :

But the point is that you shouldn't be worried about a personal guarantee if you are pushing 50K a month through the account.

Customer:

yes. right

Customer:

we can pay it

Customer:

we will make probably $5000+ for the $953.00 paid...probably more

Stephen G. :

Sure, but I would need to do the calculations by month. Each $5,000. will have a different annual borrowing rate.

Stephen G. :

That's like giving away 20% of your profits for 4 months.

Stephen G. :

Do you need the extra inventory & will it create additional sales?

Customer:

I don't need it.

Stephen G. :

If not why do it at all?

Customer:

But

Customer:

WEll, let me explain...

Customer:

This is a new program through PayPal. You never know when you might need a small cash infusion.

Customer:

I worry that if I don't try the program during this rollout phase

Customer:

that we may be taken off of the table in the future

Stephen G. :

It sounds to me like what you really need is a working capital line of credit from a commercial bank.

Customer:

Only select businesses were given the offer during the rollout

Stephen G. :

So they say

Customer:

I see.

Customer:

It's expensive money you're saying

Stephen G. :

Businesses with sufficient transactions running through Paypal.

Stephen G. :

Yes it is extremely expensive.

Stephen G. :

Look at it this way.

Customer:

OK...go ahead...

Stephen G. :

If you only have a $20,000. loan for 1 month rather than 12, what is the interest rate on that loan for 1 month.

Stephen G. :

20,000. / 953. x 12=

Stephen G. :

almost 60% rate (5x12=60); so while the number doesn't sound that bad, you only have the 20K for a month or less, depending upon how they charge your account; could be even less time than a month.

Customer:

I'm sorry. I'm not following that example...

Stephen G. :

It is basically what you computed before x 12 rather than 4months to get an annualized figure. Now that would only be on the first $5,000., of the 20K.

Customer:

i see

Customer:

4.8% on the first 5000

Stephen G. :

The 4.8% you computed, is based upon have the $20,000. outstanding for 1 year.

Customer:

I know business but I never took accounting and I don't know the formulas. I'm sorry if I am ignorant...

Stephen G. :

You only have the $20,000. for 1 month or less.

Customer:

right

Customer:

with us

Customer:

they would get back $1000.00-$2000.00 in one week

Stephen G. :

So you don't get the use of the money for a year, only 1 month.

Customer:

right

Customer:

I see

Stephen G. :

Not even a month

Customer:

right

Customer:

about 1-day

Customer:

lol

Stephen G. :

So the effective interest RATE is over 60% easily

Customer:

Thats crazy

Stephen G. :

What is confusing is the payment of the 953. is fixed

Stephen G. :

The problem is what you are comparing it to.

Customer:

So even if I could sell $20,000 in inventory in 4 months and make $5000.00+ profit, you think this is a bad deal?

Customer:

To simplify

Stephen G. :

So, if I said I'd loan you $20,000. for either 4 months or 1 year & the interest payment is the same dollar amount, which one would you take?

Customer:

1 year

Stephen G. :

I rest my case.

Customer:

of course

Customer:

So this loan is for somebody in a totally different boat...

Stephen G. :

If you want to borrow money at 60%+ & will pay that, you'll have people lined up at your door.

Customer:

It's ironic

Stephen G. :

Apparently you aren't that desperate.

Customer:

that all people offered this

Customer:

have the cash flow to pay it

Customer:

No. We're doing just fine

Customer:

I just thought it might be a good back-up emergency tool

Customer:

but you say skip it

Stephen G. :

That's why no when you don't need it, is the time to set up a business line of credit as a cash flow backup situation; you should have that in any case for emergencies.

Customer:

Find a bank that will do it based on cash flow/sales history?...At $600,000.00+year, what would an acceptable line of credit be to ask for?

Stephen G. :

If you have those kinds of numbers with that kind of gross profit, you should have no trouble getting that kind of loan at a market rate of interest. I would tell a client of mine to have $50K line, approximately 1 month's revenue.

Customer:

All without personal guarantees or tangible assets as collateral?

Customer:

Is no problem?

Customer:

OK. One month's revenue.

Customer:

I'll pursue that now while we don't need it.

Customer:

You've been a big help. Thank you for your advice.

Stephen G. :

Well, I don't know enough about your company to say that, but most small business in today's economy has to have the owner's personal guarantee for these types of loans; a working capital line of credit would normally be secured by inventory or accounts receivable.

Stephen G. :

One problem you may have is to what extent your business activity isn't run through the bank; they aren't going to loan you anything without your business;

Stephen G. :

If you need to contact me again with any tax or financial questions, you can just ask for "Steve G" at the beginning of your question. Thanks again for using us for your tax and financial questions. You may get a short survey from the site; if it isn't too much trouble I would appreciate it if you would answer it; the survey results are used to rate our performance;

Customer:

OK Steve. Take care.

Stephen G. :

Please remember to rate my response; it is the only way we get credit for our work.

Customer:

I will. A+

Stephen G. :

Thanks for using JustAnswer.com

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