What are Borrowing Costs?

Jim B.
Jim B.
Man climbing a rope
Man climbing a rope

Borrowing costs are any costs incurred by a company or business in the process of borrowing funds from lenders in an effort to grow business. The most obvious and significant of these costs are interest payments, which are offered to lenders in addition to the return of the principal of the loan. In addition, borrowing costs may arise from penalties incurred by making late payments or overdrafting from accounts. These costs are listed as expenses for tax purposes, unless they are tied directly to the purchase of a specific product used by the business.

There is rarely an occasion where a business can grow to a significant level without some sort of financing help. Companies may turn to banks or other established lending institutions as a way to acquire funds. These funds may then be used to conduct daily operations, to purchase a piece of equipment, or to undertake some new business initiative. To acquire these funds, a business must be ready to deal with the costs that go along with them, also known as borrowing costs.

Interest payments due to lenders are the borrowing costs that most companies incur in the course of business operations. When a company borrows money from some sort of lender, it does so knowing that it must pay the loan back at some point in the future along with interest due. These interest payments are the way that lenders make money and receive compensation for the possibility that the loan will not be repaid.

Other borrowing costs may be incurred by a company that fails to meet its debt obligations in a timely manner. For example, imagine that a company has a loan that is due to be repaid via monthly installments to the lender. If a month arises in which the borrowing company cannot make the necessary payment, the lender can add a penalty payment. Should payments continue to be late, these penalties can add up to a significant amount over time.

A company should always be aware of these borrowing costs and should make sure that they not rise to an unmanageable amount. Investors often study ratios that measure the amount of income a company has in conjunction with the debt the company has accrued. If these ratios are unfavorable to a company, investors will likely take it as a sign of financial weakness. On the other hand, a company should always be ready to borrow wisely to grow the business to a level where it can sustain itself.

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