With the RBA cash rate increasing again, the cost of finance is firmly back in focus for farming businesses and agribusinesses.
When rates move, it is natural to look first at the interest rate being charged by your bank. You might also ask: What is my margin? Is it competitive? Could I get a better rate elsewhere?
These are important questions, but they don’t necessarily tell you what your banking is really costing your business.
Banking structures and letters of offer have become increasingly complex. To properly review your finance, you need to look beyond the headline interest rate and margin and understand the total cost of your banking.
Look beyond the margin
Your margin remains an important part of your finance structure, but comparing margins alone can be misleading.
The way banks calculate and present interest rates can vary. Depending on the facility, a rate may be based on a market rate plus a margin, while other facilities may use a bank reference rate with an additional customer margin applied.
That means two facilities with what appear to be similar margins may have quite different overall costs.
Then there are the costs sitting outside the interest rate itself.
Depending on your facilities and bank, these can include:
- line or facility fees
- unused limit fees
- establishment or application costs
- account and transaction fees
- other ongoing banking costs.
Rather than asking only “What interest rate am I paying?” or “What is my margin?”, a better question is: “What is the total annual cost of my banking?”
Understand what you’re paying for
The next step is understanding whether the facilities you’re paying for remain appropriate for your business.
A working capital facility with a higher limit provides additional flexibility, for example, but it may also attract line or unused limit fees. That doesn’t necessarily mean the facility is poorly structured. The additional capacity may be valuable to the business, particularly where seasonal conditions or cashflow requirements can change quickly.
The important thing is knowing what you’re paying, why you’re paying it and whether the structure still makes sense for your business.
The same principle applies across term debt, working capital and equipment finance. Each facility should be considered as part of your overall finance structure rather than simply looking for the lowest individual rate.
Look beyond the headline rate
While understanding the total cost of your banking is important, there are other factors to consider as part of a review.
Fixed and variable facilities can provide different levels of certainty and flexibility. Before fixing a rate, it is important to understand potential break costs and any financial implications if you want to reduce or repay the facility earlier than expected.
If your business holds cash in at-call accounts or term deposits, review the interest being earned. As lending rates increase, it is worth making sure your deposit rates remain competitive too.
Equipment finance should also be considered as part of your broader finance structure, with repayments and facility terms aligned to the cashflow requirements of the business.
A competitive finance structure should balance cost with the flexibility the business needs today and may need in the future.
Be proactive about working capital
Cost is only one part of managing finance well. Having the right facilities available when you need them is equally important.
Understanding your future funding requirements is just as important as reviewing what you’re paying today. Keeping your cashflow forecasts up to date and reviewing working capital limits early gives you time to approach your bank and consider your options, rather than seeking additional funding when cashflow is already tight.
Three things to consider when reviewing your banking
- Understand the total cost
Look beyond the headline rate and margin. Consider interest, line fees, unused limit fees, account fees, establishment costs and other ongoing charges to understand what your banking is costing your business each year.
- Review your structure regularly
A facility that suited your business several years ago may not necessarily suit it today. As a general guide, we recommend undertaking a comprehensive review and market comparison at least every three years, or sooner if your business or funding requirements have changed.
- Compare like with like
Different banks can structure and price facilities differently. When comparing options, make sure you’re looking at the total cost, facility structure and flexibility rather than simply comparing the quoted margin or interest rate.
Know the true cost of your banking
With interest rates moving higher, now is a good time to take a closer look at your banking.
But don’t stop at the interest rate.
Understanding the total cost of your facilities, how those costs are calculated and whether your finance remains appropriate for your business can give you a much clearer picture of your position.
At SproutAg, we work with farming families and agribusinesses to independently review and benchmark their finance structures, helping them understand the true cost of their banking and whether their facilities remain competitive and fit for purpose.