The short answer
An interest rate is charged per year. A trading margin is earned per transaction. Comparing them directly tells you almost nothing, because one of them repeats and the other does not.
If you can put money into stock, sell it, get paid and put the same money back into stock again, you earn your margin every time you go round. The interest keeps running at the same annual rate no matter how many times you do it. So the question is not whether the rate is higher than the margin. It is how many times a year you go round.
The catch is that most of the facilities sold to small businesses are structured so that you cannot go round at all. That is the part worth reading carefully.
Why the two numbers do not compare
Take a business importing goods. It puts in $100,000, sells the shipment for $120,000 and gets paid. That is $20,000 on the money it put in, or 20%.
Now borrow the $100,000 at 25% a year. A year of interest is $25,000, against $20,000 earned. On one trip round, the deal loses money and the instinct was right.
But nothing says you only go round once. If that whole cycle takes three months, the same $100,000 does it four times. The interest is still $25,000, because interest is charged for the year, not for the trip. The margin is now $80,000.
The rate did not change. The number of turns did.
This is why the comparison feels wrong to people who run trading businesses and feels right to people who do not. An accountant looking at the rate against the margin is comparing an annual figure to a per-transaction figure, which is like comparing an annual salary to an hourly wage and concluding the hourly one is worse.
The break-even number of turns
There is a single sum behind all of this, and it is worth committing to memory.
Break-even turns = annual rate ÷ return per turn
At 25% a year and 20% earned on each turn, that is 25 divided by 20, or 1.25 turns. Go round more than one and a quarter times in the year and the facility has paid for itself. Everything past that is yours.
Two things about that sum matter more than they look.
The return is on the money you put in, not the margin on the sale price. These get mixed up constantly. If you buy for $100 and sell for $120, you made 20% on your money, but the accountant calls that a 16.7% gross margin because it is measured against the sale. For this sum you want the first number, because the question is what each dollar of borrowed money brings back.
Break-even is usually a low bar. At almost any realistic combination of rate and margin, break-even lands somewhere between one and three turns a year. A business with stock sitting for six months struggles to get there. A business turning stock monthly clears it in the first quarter.
How many turns do you actually get?
Your number of turns is decided by your cash conversion cycle, which is the number of days between your money leaving and your money coming back. Work it out like this:
| Days your stock sits | From arriving in the warehouse to being shipped to the customer |
|---|---|
| Plus days your customers take | From invoice to cash in the bank. Use what they actually do, not your terms |
| Less days your suppliers give you | Trade terms are free funding and shorten the gap you have to finance |
| = your cash conversion cycle | Divide 365 by this to get your turns per year |
A worked one. Stock sits 45 days, customers pay in 30, suppliers give 30 days. That is 45 plus 30 less 30, so a 45 day cycle, or roughly eight turns a year. Against break-even of 1.25, that business is not close to the line.
Against the same 25% facility and 20% per turn, illustratively:
| 90 day cycle | 4 turns, 80% earned, 25% paid |
|---|---|
| 60 day cycle | 6 turns, 120% earned, 25% paid |
| 45 day cycle | 8 turns, 160% earned, 25% paid |
Those figures are illustrative and assume you can actually sell every cycle, which is the assumption doing the heavy lifting. More on that below.
Where the argument breaks: the term loan trap
This is the part most owners are never told, and it is the difference between the sum above being true and being a fantasy.
The argument depends on the money coming back to you so you can send it out again. On a revolving facility it does. You draw, you trade, your customer pays, you repay, the limit is available again and you draw for the next cycle. Interest is charged only on what is drawn.
A short-term business loan does not work that way. It pays out once and then takes it back in daily or weekly instalments. Two things go wrong at the same time.
You never get to recycle. The principal is being repaid, not revolved. There is no second deployment. You get one trip round, and on one trip the 25% against 20% comparison was right all along.
The money is leaving while you are still paying for it. Because you are repaying from day one, your average balance across the year is roughly half what you borrowed. You pay a year of interest on the full amount while having average use of half of it, so the effective cost of the money you actually had is closer to double the headline.
Put those together and a facility advertised at 25% behaves, for a business trying to fund a trading cycle, more like 50% on one turn. That is not a structure to recycle money through. It is a structure to buy a piece of equipment with, or to cover a one-off gap.
So the honest version of the argument is narrower than the version you hear from lenders: the number of turns only saves you if the facility lets you turn.
Three more things that eat the advantage
A fee on every drawdown. Some facilities charge each time you draw. That is tolerable if you draw twice a year and quietly expensive if you draw eight times, and it punishes exactly the behaviour that makes the facility worth having. A single line fee on the limit is far better for a business that turns quickly. Ask how the fee is charged before you ask what the rate is.
Gross margin is not profit. That 20% has to cover rent, wages, freight, platform fees, returns and everything else before any of it is yours. The argument survives this, because the interest also comes out of the same pool, but it shrinks. Run the sum on what genuinely lands after the cost of the goods and the cost of selling them, not on the headline markup.
The cycle has to finish. This is the real risk, and it is not the rate. If debtors drift from 60 days to 90, your turns drop by a third and so does the whole benefit. If stock does not sell, you have not converted cash into margin, you have converted cash into inventory sitting in a warehouse, and the interest keeps running. A business with concentrated customers or seasonal stock should be conservative about how many turns it counts on.
Which facilities actually let you recycle
Three do it properly, and they are worth knowing apart.
A business overdraft sits against your trading account. You use it without asking, interest runs only on what is down, and it goes back up when money lands. The most natural fit for a cycle that repeats.
A line of credit is a limit you draw against deliberately. Slightly more structure than an overdraft and usually a little cheaper, which suits a business that draws for a known purpose rather than dipping in and out daily.
Debtor finance advances against invoices as you raise them, so the facility grows with your sales rather than being a fixed number. It suits a business whose cycle is dominated by customers paying slowly rather than stock sitting.
What all three have in common is that interest runs on the drawn balance and the limit comes back. That is what makes the number of turns mean anything. Working capital finance is the general name for sizing any of them to your cycle rather than to a round number.
What this does not mean
It does not mean expensive money is fine. A lower rate is still better than a higher one at the same number of turns, and getting the rate down is most of what we do. The point is only that the rate is not the whole question, and treating it as the whole question makes businesses turn down funding that would have made them money.
It also does not apply to everyone. A services business with no stock does not have a trading cycle in this sense. Its constraint is people and time, not inventory, and the sum above will mislead it. This argument is for businesses that buy something, sell it and get paid: e-commerce and online retail, wholesale and distribution, importers, and trade businesses buying materials for jobs.
And it assumes demand exists. Funding lets you buy more stock. It does not make anyone buy it from you. If the constraint on your growth is customers rather than cash, more funding solves nothing and costs 25%.
What we would ask you
If you come to us with this question, these are the numbers we want before saying anything useful. Most owners have them in their head already.
- What you make on each dollar you put into stock, after the cost of the goods and the direct cost of selling them.
- How long stock actually sits, measured rather than estimated.
- How long your customers actually take, which is rarely the number on the invoice.
- What terms your suppliers give you, and whether they would give more.
- Whether you could sell more if you had more stock, honestly answered.
From that we can tell you how many turns you really get, what break-even looks like at the rates available to a business like yours, and whether the answer is a revolving facility, a term facility or neither. Sometimes the answer is that better supplier terms would do the same job for nothing, and we will say so.