In general, having debt is not viewed as a positive. You’ll never meet a financial advisor who tells you that you should be carrying more debt. No individual ever aspires to one day have six figures of debt. In fact, it’s extremely easy to go into debt with just a few purchases, and it can take years of hard work and discipline to get out of it.
A large reason debt can become so dangerous is because of interest. If you purchase a car for $10,000, you don’t only owe the flat $10,000. You will actually owe $10,000 plus a percentage, which means you might end up paying $15,000 or even more. This is why many people find themselves more deeply in debt than they expected.
However, debt is viewed differently inside of growing businesses. When companies or small businesses have debt, they get a tax deduction on the interest they pay. Therefore, some businesses actually use debt as part of their growth strategy. In order to successfully do this, they must heavily rely on learning how to calculate after-tax cost of debt.
If you are struggling with tax problems, there is help available. Call the Tax Debt Relief Helpline to speak with an IRS tax relief counselor for free advice. Learn more about the Tax Debt Relief Helpline here.
Cost of Debt Example
All debt has a cost. Interest is basically a fee you pay to a lender for them to hold your loan. The longer you hold on to your loan, the more you will pay in interest. Any time you take out a loan, you probably pay special attention to the interest rate. One small loan can cost you thousands of dollars over time if it has an extremely high interest rate. The cost of debt is the total amount of money you are paying a lender to hold your loan, and it does not include the original loan amount.
Cost of Debt for Employees
You probably know the interest rate you have on any of your debt. For example, you may have a $10,000 loan at a 10% interest rate. Ten percent of ten thousand is $1,000. If you pay your loan off on time, the cost of debt will be $1,000.
However, this calculation isn’t usually reliable for consumers. For one, if you miss payments or pay extra on your payments, the total amounts will change. Unlike the calculating the cost of debt for businesses, it also doesn’t take taxes into account. If you are an employee and you’re getting any kind of personal loan, taxes will not affect your payments. Payments for personal loans are not tax deductible.
Cost of Debt for Companies
On the other hand, the interest on business loans are tax deductible for businesses. Calculating the actual cost of debt after deductions offers a more accurate figure when considering taking on business debt. To calculate the after-tax cost of debt, they need to know their loan amount, the interest rate, and tax rate.
How to Calculate After-tax Cost of Debt
To calculate the after-tax cost of debt, you start by multiplying the loan amount by the interest rate to get the pre-tax cost of debt. Then, you multiply the result by the tax rate to get the income tax deduction. Finally, you subtract the income tax deduction from the pre-tax cost of debt to get your after-tax cost of debt. Here’s an example:
A corporation takes out a $150,000 loan at a 10% interest rate. They have a 40% tax rate.
Their pre-tax cost of debt is 10% of 150,000 (150,000 multiplied by .10), which is $15,000.
40% of $15,000 (15,000 multiplied by .40) is $6,000.
Finally, $15,000 subtracted by $6,000 is $9,000. The after-tax cost of debt is $9,000.
What is the Cost of Debt Used For?
The after-tax cost of debt calculation is often used as a tool for companies to grow. 43% of small businesses seek funding for their business at some point. There are a multitude of funding opportunities for businesses, from small business loans to lines of credit to equity financing and more. When they can accurately evaluate the risks and benefits to holding debt, companies can use debt strategically to finance growth.
A company’s cost of debt can change over time as other financial factors change. There will likely be a time when the cost of debt is low, and it is a useful tool to growing a business and increasing revenue. However, just like individuals, companies who don’t keep track of their finances can easily allow debt to get out of control.
If you are in trouble with your business finances, you can talk to a tax debt professional at the Tax Debt Relief Hotline. It’s a free resource that gives you access to professionals who know exactly how to help you.
Why You Need to Know Your After-Tax Cost of Debt
Although debt is not viewed as a financial asset, it is possible to use it as a tool to grow a business. You don’t need to be a financial professional to learn how to calculate after-tax cost of debt. You can use your cost of debt to assess if carrying debt is a wise investment for your business at every step.
If your company’s finances are not managed wisely, you may find yourself sliding deeper into debt. For free expert advice to assist with any tax problem, help finding tax debt forgiveness, or other solution, contact the Tax Debt Relief Helpline at (888) 452-7841.