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As I wrote in Barking With The Big Dogs, the saying is true, "debt is a four letter word...it has
four letters". However, borrowing money is not always a bad thing to do, unless you preach debt is
dumb.

Many times saying all debt is dumb is easy advice to give. For example, let me ask the question,
"do you like to pay interest to someone else, or do you want to save and keep the dollars for yourself?"
From a salesman's perspective, the previous question was a leading question. The answer was already
known. Everyone wants to keep money versus giving the funds to someone else. Therefore, telling
people debt is stupid or dumb is easy advice to give (or sell). No other explanations are necessary.

Well, I'm not interested in stopping here, some explanation is required for true financial
knowledge instead of simply rehashing the obvious mass amount of common knowledge already in
existence.

In answer to the title of this topic "Is it smart to pay 10% interest on inventory?", the answer is - it
depends?

Sorry, I know the response 'depends' sounds like an answer out of Washington during a press
conference, but in the case of borrowing money, sometimes, borrowing money is not wise and other times
using financing is very smart. Let me explain...

When purchasing inventory, two choices exist. One, pay cash or net 30 days for open accounts
with a vendor. Two, get a loan. I'll address the latter.

Let's say a loan is considered for purchasing inventory. The inventory can be t-shirts, flowers,
groceries, etc. - even money. If the inventory is speculative, those items may not sell and a double
whammy occurs. Loss on the products; loss on the interest. However, if a loan is taken out on staple
items (‘
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probability of sales occurring is high. Unfortunately, many staple items have lower margins and the
added cost of borrowed money makes profit more difficult. Profit, though, can be based upon a couple of
things.

First, the margin and second, the turnover.

Looking at margin to begin, let's say $1,000 worth of goods is purchased. If the loan is for one
year at 10%, the interest owed is $100 when the note is due next year (assuming payments have not been
made and the loan is similar to a balloon payment, production or season type of loan). Adding $100 to
the cost of the merchandise makes the products cost $1,100 in the end. Selling the items for $2,000 has a
high margin creating a nice profit and borrowing money makes sense. The answer to the original
question here is - yes.

Getting away from high margins to low margins, let's look at the other scenario. What if the
margin is only ten percent on the inventory purchased?
 Buying $1,000 worth of goods at 10% makes the cost $1,100 as we have already determined.
Selling the inventory for $1,100 at the end of the year, using 10% profit added to cost, creates $0 profit
since the borrowed money is also $1,100 at year-end. In the current example mentioned, borrowing
money is not a wise choice. However, what if the inventory is turned two times per year? (i 

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) Paying one hundred dollars interest to the bank still happens, but $200 profit is a result.

If I buy something for $1,000 and add the interest, the cost is $1,100 at year-end, but since I'm
selling twice a year, I made my $100 profit twice while paying interest only once. Remember, my
purchase price is $1,000 and my selling price is $1,100 creating a $100 profit. I simply take the original
$1,000 and put the funds back to work. By making two sales per year, my profit becomes $200 against
the $100 interest owed.

If I sell my items twelve times per year, or monthly, my profit is big. For simple math, I make
$100 per month, or $1,200, and only pay $100 for the interest once a year. The net effect is I make
$1,100 net profit.

As a result of turnover, I did not make 10% on my money, I made over 100% (or more than
double) on my money while costing only 10% on the original balance.

In essence, my rate of interest was less than 1% per inventory turn! ($100 divided by 12 = $8.33
which is less than 1% on $1,000.)

Depending on what I am selling, if I had to add 10% to my cost, my selling price would be much
higher in order to profit. However, if I add 1% to my cost, my price can be lower than the competition
thus allowing me to sell more - or increase my turnover; thus creating more profit and increase my cash
flow.

Speaking of cash flow, rather than pay principal and interest payments, I can simply pay the
interest, $100 per year, and keep the process going. If the bank won't allow such actions, I can roll the
note by simply paying off the existing loan with a brand new note each year and pay just the interest.
(There's more than one way to skin a cat.)

In the game of borrowing money, profit is key. The real answer to borrowing money and
determining if the action is dumb or wise depends on profitability and - discipline as well. Discipline is
something even the debt-free pundits say is necessary to gaining wealth.

In the end, is borrowing money smart? It depends.

Copyright. 2010. Mark Harrison.