When a business owner looks at a profit and loss statement, it’s pretty clear what items affect the cost of doing business: payroll; rent; utilities; inventory purchase price; etc.

What is harder to see is what accountants and business consultants call “Opportunity Costs.” The World English Dictionary defines opportunity cost as: “the money or other benefits lost by pursuing a particular course of action rather than a mutually exclusive alternative.” In other words, if you decide to go with Option B, you will lose any benefit you would have gotten from Option A or C.

As an executive or owner, you want to minimize opportunity costs. It does this by weighing the benefits and drawbacks of EACH of the options before you. This allows you to get a clear picture of each possibility and allows you to select the option that best meets your immediate (and possibly medium-term) needs. Once that decision is made, move on.

For whatever reason, when it comes to business financing, most owners and top executives overlook the Opportunity Cost assessment. Why? I think it’s because they tend to outweigh the definable cost of money over all the other costs associated with business financing.

Let me explain. Opportunity costs are not limited to monetary or financial costs. They rightly also include:

• Sales not pursued (because there is no cash available to cover the associated costs, leading to a loss of profit)
• Supplier discounts not applied (causing lost profits)
• Lost time (time spent searching for a financing alternative when a different alternative could have been consumed more quickly; this means the executive’s time is wasted, which can result in lost profits)
• Emotional impact on the owners, the family of the owners, the employees and their families (the stress associated with the financial problems of the company has implications on many levels)

These are very real but not tangible things and because they are not tangible, the tendency is to ignore or dismiss their impact on the financial health of the company. That’s a huge but understandable mistake.

It’s understandable because virtually all financial institutions (both traditional and non-traditional) will focus on the numbers when underwriting a transaction. They should do it because they are evaluating the risk. Therefore, it makes sense for the borrower to focus on “the numbers” as well. That is, the tangible cost of money.

Unfortunately, focusing solely on the numbers almost always means overlooking opportunity costs, costs that can be substantial. I’ve seen too many homeowners delay action for weeks in an attempt to save a quarter of a percent on the cost of money. Frequently, the delay resulted in a loss of revenue and profit that was an order of magnitude greater than the cost of money. To use an old adage, they were wise with pennies but dumb with pounds.

It is not necessarily easy to assess opportunity cost in a financial situation. This is because most banks/finance companies will not help with the analysis. After all, they want to seal the deal to present the benefits of their specific course of action, regardless of whether it is the optimal solution for you at the time.

It is up to the owner/executive to assess their Opportunity Costs. The optimal decision might mean paying a slightly higher cost of money to get funding early enough to take advantage of an opportunity. After all, what good is saving $1,000 in cost of funds if you lose $10,000 in additional earnings?

There are quite a few options for business financing. They include:

• bank loans (either direct or SBA guaranteed)
• personal credit (credit cards, home equity, etc.)
• borrow from friends and family
• sale of company shares (capital dilution)
• invoice factoring
• merchant account financing
• fundraising
• various forms of asset-based loans

Some of these can be immediately ignored based on an understanding of your position in the world of credit. For example:

• If your company is less than 2 years old, you will not get a bank loan
• If your business offers a consumer product or service, you won’t have Accounts Receivable to factor.
• If your personal credit is bad, your chances of getting into debt are slim to none.

Once you can determine which options are available to you, it’s time to assess both the direct cost and the opportunity cost associated with each option to determine which one gives you the most immediate advantage. Once you know that, take the option and build your business.