The True Cost of Debt Financing: What UK SMEs and CFOs Need to Know
This article is part of our Debt Financing Guides for UK Businesses. Read the full guide
The number most borrowers focus on is not the most important one
When a UK business evaluates a debt financing offer, the conversation almost always starts with the interest rate. It is the most visible number and the easiest to compare across lenders.
It is also, on its own, one of the least useful metrics for understanding what you will actually pay.
The true cost of debt financing includes the interest rate, but it also includes arrangement fees charged upfront, the structure of how interest is calculated, any minimum usage or commitment fees, early repayment penalties, and — most commonly overlooked — the cost of capital you borrow but do not actually use.
For a CFO doing proper due diligence before signing a facility, each of these components needs to be assessed together.
Component 1: Arrangement fees
Most debt financing products carry an arrangement fee — a one-off charge for setting up the facility. This is typically expressed as a percentage of the facility amount and deducted from the first drawdown or paid upfront.
Arrangement fees reduce the effective net amount you receive on day one. A £500,000 facility with a 2% arrangement fee costs £10,000 upfront, meaning your net receipt is £490,000 while you pay interest on £500,000.
When comparing facilities, always express the arrangement fee as a component of total cost, not as a separate line item. An arrangement fee on a short-term facility is proportionally more expensive than the same fee on a longer-term one.
Component 2: How interest is calculated
This is the variable that most significantly affects the total cost of a facility, and it is rarely explained clearly in headline comparisons.
For a term loan: interest accrues on the full outstanding balance for the life of the loan. As you repay principal, the balance reduces and interest accrues on the lower balance. But in the early months, you are paying interest on the full amount borrowed — including capital you may not yet have deployed.
For a revolving credit facility: interest accrues only on the drawn balance. If your facility limit is £500,000 and you have drawn £200,000, you pay interest on £200,000. Repay £100,000 and your daily interest cost drops accordingly. If you draw nothing for a period, your interest cost is zero (subject to any commitment fee).
Key insight: For businesses whose capital need varies month to month — as it does for most working capital situations — a revolving credit facility almost always costs less in total than a term loan for the same headline amount, because interest accrues only on what is actually used.
Component 3: The cost of idle capital
This is the most frequently underestimated component of debt financing cost.
When a business takes a fixed-term loan for more than it needs at any given moment — which is common, because lenders prefer to issue in round numbers and businesses prefer headroom — the business pays interest on the full balance, including on capital it has not deployed.
Illustrative example: A UK retailer needs £200,000 for stock at the start of Q4 and a further £150,000 for a store refurbishment in Q1 of the following year. They take a term loan for £350,000 to cover both needs. For the first four months, they are paying interest on £350,000 while only £200,000 is deployed. The £150,000 earmarked for the refurbishment is sitting in their current account, accruing interest costs while generating no return.
Under a revolving credit facility, they would draw £200,000 in Q4, repay as Q4 revenue lands, then draw £150,000 for the refurbishment in Q1. Interest accrues on the drawn balance throughout, not on an aggregate sum decided in advance.
This is an illustrative example. Actual costs depend on lender terms and individual lending criteria.
Component 4: Commitment and non-utilisation fees
Some revolving credit facilities charge a commitment fee — a percentage applied to the undrawn portion of the facility. This is designed to compensate the lender for keeping capital available that the business is not currently using.
Before signing a revolving credit facility, check whether a commitment or non-utilisation fee applies and how it is calculated. For businesses that genuinely need the full facility most of the time, this fee may be negligible. For businesses using only a fraction of their limit regularly, it becomes a meaningful cost component.
Component 5: Early repayment charges
Term loans frequently include an early repayment charge — a penalty for paying off the loan ahead of schedule. This is designed to compensate the lender for the interest income they lose when a borrower exits early.
Early repayment charges typically range from a small percentage of the outstanding balance to the equivalent of several months' interest. They make fixed-term debt expensive to exit if your circumstances change: a refinancing opportunity arises, the business is acquired, or cash flow improves enough to clear the debt.
When assessing a term loan, always ask for the full early repayment penalty schedule and model the cost of exit at 12, 24, and 36 months.
Revolving credit facilities typically do not carry early repayment penalties in the same way. Repaying the drawn balance simply restores availability — it does not trigger a fee.
Total cost per £ drawn: the right comparison metric
Rather than comparing headline interest rates, CFOs assessing debt financing options should calculate the total cost per £ actually drawn over the expected facility period.
This calculation incorporates: arrangement fee (amortised over the expected term), interest on drawn amounts (based on expected utilisation), commitment fees on undrawn amounts (if applicable), and expected early repayment penalty (if there is a realistic chance of early exit).
Illustrative comparison: Assume a business needs £300,000 of working capital at any given time over a 12-month period, but expects to draw and repay multiple times as the cash flow cycle turns.
- Under a term loan: interest accrues on the full £300,000 for 12 months, plus an upfront arrangement fee, plus a potential early repayment penalty.
- Under a revolving credit facility: interest accrues only on the average drawn balance (which, with active repayment and redrawing, may average £150,000 over the year), plus an arrangement fee amortised over 12 months, with no early repayment charge.
In this scenario, the revolving credit facility carries a significantly lower total cost despite potentially carrying a higher headline rate, because interest accrues only on capital actually used.
This is an illustrative comparison. Actual costs depend on lender terms, utilisation patterns, and individual lending criteria.
What a CFO should check before signing
Before committing to any debt financing facility, verify the following:
- Arrangement fee: expressed as a percentage of facility amount; confirm whether deducted from first drawdown or paid separately.
- Interest calculation basis: daily on drawn balance (revolving) vs on full outstanding balance (term loan).
- Commitment fee: percentage and whether applied to undrawn or total facility.
- Covenant obligations: minimum revenue, profitability, or balance sheet ratios that could trigger mandatory repayment if breached.
- Early repayment terms: full schedule of penalties for exit before the stated term.
- Review cycle: for revolving facilities, how often the lender reviews and potentially adjusts the facility limit.
- Security requirements: debenture, personal guarantee, or asset-backed — and at what facility size each applies.
How Juice Flex is structured
Juice Flex is a revolving credit facility for UK SMEs, from £50,000 to £1,000,000. Interest accrues on the drawn balance only. Repayments restore the available limit without reapplication. Each draw has agreed repayment terms up to 24 months, with early repayment always free; the facility itself revolves and does not expire.
For CFOs evaluating total facility cost, security requirements vary by facility size; full criteria are confirmed on application.
Subject to status and lending criteria.
Key takeaways
- The true cost of debt financing includes the interest rate, arrangement fee, the structure of interest calculation, commitment fees, and early repayment penalties.
- How interest is calculated — on drawn balance only vs full outstanding balance — is often the most significant cost variable.
- Idle capital has a real cost: a term loan for more than you currently need charges interest on the unused portion.
- Total cost per £ drawn is the right metric, not the headline rate alone.
- Revolving credit facilities tend to be more cost-efficient for recurring, variable working capital needs because interest accrues only on what is used.
Ready to assess what a revolving credit facility would cost for your business? Explore Juice Flex or check your eligibility — no impact to your credit score.