Understanding the total cost of credit is critical to making sure you get the best deal on business finance. It’s amazing (but perhaps not surprising) how many finance providers aren’t transparent about the full cost of credit.

The UK Competition and Markets Authority published its provisional findings on 22 October into the supply of banking services to small and medium enterprises. Their work confirms that the high street banks have a stranglehold on the business current account (and overdraft) market, and that action is needed to stimulate competition.

The CMA findings also confirm that SME charging structures are complex and difficult to compare, and that SMEs don’t switch bank providers because they are concerned about access to finance.  One of their recommendations is that a specific price comparison website for SMEs is set up.

However, at present there is no requirement for commercial finance products to carry the Annual Percentage Rate (APR), which takes both interest and fees into account. Without a standard price indicator, it is difficult for SMEs to compare prices, even if the proposed remedies are adopted.

This is badly needed to help simplify the complex charging structures used to charge SMEs more than they anticipate.  If this was implemented, it would help decrease the cost of SME finance, and increase business and economic growth.

Exactly how much is that piece of the pie?

In the meantime, here is a short list of tricks you should watch out for, and tips you can use to uncover the true cost of borrowing, to make sure you’re getting the best deal for your business.

1) Focus on just one ‘headline’ component e.g. the interest rate

Invoice finance providers are perhaps one of the worst offenders here.  Businesses are often attracted by low interest rates – often quoted in the low single digits e.g. 3%.  First of all, check that this is an annual rate, not monthly or daily!

Second, check, what other costs are payable beyond interest. Providers often use low interest to divert your attention from other components of the cost, particularly the fees.  If the rate sounds too good to be true, it probably is!

Top tip: Ask providers what the APR of their credit is, including any fees. If you don’t get a straight answer, walk away.

2) Fees, fees, fees

Any fees that you are charged for your credit facility by your provider are adding to the total cost of the finance provided.  This sounds obvious, but prospective customers comparing costs often forget to include fees.

For many commercial finance products, the fees actually represent the vast majority of the cost!  If you ever thought banks weren’t innovative, take a look at the variety of ways (and names) that they’ve come up with to charge you fees.

Top tip: Make sure you check the terms and conditions carefully for hidden fees.

3) Express the cost of credit in a way that makes it hard to compare the true cost

“With interest rates from just 0.05% per day you could borrow £100,000 for just £50 a day” sounds enticing, but assuming no compounding, that’s over £18K per year in interest – an annual rate of 18%.  And on a compounded basis it’s even higher at 20%.

Top tip: Watch out for any provider that presents the cost of credit without reference to an annual interest rate, and particularly without a time dimension – it’s a warning sign that usually means you’re being charged a lot more than you think.

Low interest rate loans can magically mount up

4) Offer a big limit which in reality is hard to access

“Your credit limit is £100,000” is a pretty clear.  But are there strings attached?  You will often find that your limit is only accessible by meeting several conditions which in reality mean the full amount is out of reach.  That, combined with a fee based on the size of the limit, means you may end up paying for credit you can’t use.

Top tip: A good question to ask a provider is “Can I borrow the full amount on Day 1?” 

5) Not getting a full refund for credit you DON’T use

What’s worse than charging you a lot for the credit you use? Charging you for what you DON’T use! Providers do this in lots of ways, for example:

1. Charging you even if you don’t borrow (non-utilisation fees)
2. Charging you up front for credit assuming an amount and duration, and not giving you a rebate  if you pay back early
3. Charging early repayment fees
4. Using monthly calculations rather than calculating interest on a daily basis

Top tip: Check a provider’s early repayment policy by enquiring “How do you calculate early repayments?”

James is CEO at flexible finance firm Growth Street