Bought a house with a mortgage? You dealt with APR. Bought a car with financing? You dealt with APR. And if you’re running a food truck business and want to buy a new truck (which costs up to $100,000!), APR is the way to go.
But, unlike the purchase of a house or a car in your personal life, or a food tuck for your business, where you pay back in installments over a long period of time, an order of supplies or a recurring business service can be paid back relatively quickly. This means that you don't need a rate that accounts for inflation as well as compounds over time.
You need a basic number that tells you how much you will ACTUALLY pay over the duration of the repayment period.
What Does APR Mean?
Let’s first define the accounting term in a technical sense, so we can dive deeper into the discussion. Then we can talk about when, and when not, to look at rates through the lens of an APR. APR, or as in its full name Annual Percentage Rate, is the rate at which you will pay back the loan PER YEAR.
APR: A Useful Tool for Long-Term Financing
APR is the most useful metric to look at when dealing with long-term borrowing, as in buying expensive equipment, which will take you several years to pay back. The APR accounts for inflation, as well as other fees that are attached to the loan. APR is important for long-term financing. Unless you are loaded with cash and can pay off your big purchases quickly, than you will need to finance them. In these cases, APR will help you understand how much in total you will pay each year over the duration of the financing.
Where the APR Measurement Falls Short
For smaller scale purchases, you can use financing on a short-term scale, without coming close to thinking about APR, or annual interest. Especially if your business is seasonal, there will be times when you are a bit strapped for cash and need to finance a purchase here and there.
In these cases, APR doesn’t clearly reflect the true cost you will pay, since you will hopefully pay back your loan well within the year.
For example, if you finance a one-time purchase of $5,000 and are given one month to pay it back (net 30 days) at a real rate of 2% a month, then you would be paying a borrowing fee $100. But, if you calculated the APR as if you were stretching the loan over the course of a whole year, at 24% (2% per month times 12 months), then you would be paying at least $1200, plus inflation and compound interest, when relevant.
APR in Supplier and Small Business Relationships
As a supplier advertising your interest rates of the terms that you offer to customers, using the framework of APR might be misleading. The APR is bound to be a higher rate than what the customers are actually going to pay, because they are dealing with a much shorter time horizon. If you're a small business owner buying inventory or services in a range up to $20,000, or a supplier offering terms for those purchases, start thinking in terms of monthly fees instead.
So, when dealing with terms like net 30 and net 60, set aside the concept of APR. Just keep it simple.