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Cost of debt is the amount a business pays to borrow money. It includes interest, loan fees, and other financing costs.
Borrowing costs can affect cash flow, margins, and the amount of debt a business can take on. In the Federal Reserve’s 2025 Small Business Credit Survey, 86% of small employer firms said they use financing options on a regular basis, most commonly credit cards and loans.
This guide covers how to calculate the cost of debt and compares financing options for businesses.
What is cost of debt?
Cost of debt for businesses is the total cost paid by a business to borrow money. This amount accounts for interest and fees, along with other costs tied to a loan or financing product.
Many forms of business debt are considered non-dilutive funding because they provide capital without surrendering any ownership.
For Shopify store owners, cost of debt can apply when reviewing financing options such as Shopify Capital loans. Shopify Capital loan offers show the amount borrowed, repayment terms, and fee options before a merchant accepts financing.
Cost of debt is one of several financial concepts businesses use to understand how financing affects operations. Finance teams may also review EBIT, or earnings before interest and taxes, because interest expense affects pre-tax earnings.
Cost of debt is related to but different from cost of debt capital. Weighted average cost of capital (WACC) is used in corporate finance to determine a company’s financing costs. It measures the average after-tax cost of all capital sources, including cost of debt and equity.
What affects your cost of debt?
Cost of debt depends on the terms of the borrowing offer. Here are factors that affect what a business pays and how repayment fits into daily operations:
- Interest rate. A higher rate increases the yearly cost of borrowing and raises the total amount paid.
- Fees. Origination fees and other charges increase the total borrowing cost beyond the interest rate.
- Repayment terms. Shorter loan terms can raise scheduled repayment amounts, while longer terms can increase the total interest paid over time.
- Lender type. Different lenders price risk differently, so banks, online lenders, and financing providers may offer different rates, fees, and repayment structures.
- Credit profile and financial condition. A strong credit score and steady revenue help a business qualify for lower-cost financing. Lenders may also review revenue, existing debt, and EBITDA when assessing repayment capacity.
- Collateral and personal guarantees. Collateral or guarantees can reduce lender risk, which may affect pricing, approval, and repayment terms.
- Cash flow. Consistent cash flow can make repayment easier and may help a business qualify for financing with better terms.
Business owners also face approval standards that can overlook how they use cash to grow, as Shock Surplus founder and CEO Sean Reyes found.
“Banks wouldn’t lend us a dime because our average cash balance didn’t meet their metrics,” he says. “They don’t care if you’re pouring all your profits and all your cash back into the business to grow it like we were. To them, that doesn’t matter at all.”
There are nontraditional alternatives to big banks, however, they may offer less-favorable terms. For example, of small employers that borrowed from online lenders, 60% told the Fed borrowing costs were higher than expected, the largest percentage among all lender types.
Want a simple way to know how much it will cost to take out a loan? Try Shopify’s free Business Loan Calculator.
4 common fees that affect cost of debt
Here’s a closer look at four common costs that affect the total amount a business pays to borrow money:
Interest
Interest is the amount a lender charges on the loan principal annually, typically expressed as a percentage. Interest is a compensation for a lender taking on the risk of providing a loan. As borrowers make regular repayments, they pay a combination of the principal and interest.
Banks in the US determine interest rates for business loans based partly on the prime rate.
Origination fee
Lenders can charge an origination fee to cover the cost of processing a loan application. This is usually a one-time, upfront fee lenders use to assess a borrower’s eligibility, evaluate the application, and prepare the loan.
Prepayment fee
Some lenders may charge a prepayment fee if borrowers pay off all or part of their loan early. This is also called an early repayment fee or prepayment penalty. This fee is meant to supplement lost interest due to early repayment.
Late payment fee
Lenders can charge late fees if borrowers miss payment deadlines. Late fees encourage timely payments and ensure borrowers adhere to any agreed-upon repayment schedules.
Cost of debt formulas
Cost of debt can be calculated in three ways: annual percentage rate (APR), pre-tax cost of debt, and after-tax cost of debt.
APR expresses borrowing costs as an annual percentage of the loan principal. It includes both interest and added costs like fees, so it may be higher than the interest rate. APR is often spelled out in loan agreements. Here’s a simplified formula:
APR = {[(Total interest paid + fees) / principal] / loan term in years} x 100
Interest on business loans are generally tax-deductible in the US and other jurisdictions. Cost of debt can therefore be expressed in pre-tax and after-tax terms. Only the principal and interest are considered in such cases. The pre-tax formula:
Pre-tax cost of debt = (Annual interest expense / Sum of debt) x 100
The after-tax formula, which requires knowing your tax rate:
After-tax cost of debt = Pre-tax cost of debt x (1 − Tax rate)
IRS guidance states that deductible business interest expense may be limited under section 163(j), and that Form 8990 is used to calculate the deductible amount and any carry forward.
How to calculate cost of debt
Be sure to review the small business loan terms when deciding if an offer is right for your business:
- Amount borrowed
- Interest rate or APR
- Fees
- Repayment term
- Payment schedule
- Total repayment amount
Here’s an example of an APR calculation if you’re offered $500,000 at a simple interest rate of 10% over one year with a $25,000 origination fee:
APR = {[($50,000 + $25,000) / $500,000] / 1} x 100 = 15%
Note: This example uses simple interest. Business loans typically are amortized, which requires a more complex calculation. Each payment of an amortized loan reduces the principal, which reduces subsequent interest charges.
How to calculate pre-tax cost of debt
It’s important to know your cost of debt before and after taxes so you understand both the cost of repaying it in the moment and in the long-term.
Using the same loan terms as the example above, let’s calculate pre-tax cost of debt:
Pre-tax cost of debt = $50,000 / $500,000 = 0.1 (10%)
How to calculate after-tax cost of debt
Now, let’s calculate the after-tax cost of debt using the previous terms and assuming a tax rate of 20%:
After-tax cost of debt = 0.1 (10%) x (1 − 0.2) = 0.08 (8%)
The business’s after-tax cost of debt is two percentage points lower as a result of the deduction.
How Shopify Capital’s cost of funds works
Shopify Capital offers store owners loans that work differently from traditional interest-based financing. Repayments are collected from a fixed percentage of daily sales until that amount is repaid, plus borrowing fees. Store owners can pay a monthly fee until the loan balance is paid off from sales, or pay a single fixed fee.*
With the help of Shopify Capital, apparel brand &Collar was able to invest in their product and marketing, and scaled so quickly they ended up paying off cash advances within a few months.
“Candidly speaking, if we hadn’t had Shopify Capital as an option for funding, we would be two, three, or maybe four years behind where we are today. We wouldn’t have been able to keep up with demand, both from an inventory perspective and then finding new eyeballs,” says founder Ben Perkins.
Shopify Capital also has a flex account for eligible US store owners. A flex account gives merchants access to a borrowing capacity, with monthly fees applied to the outstanding balance.
In a Shopify fourth-quarter 2025 survey of store owners,** 62% reported using outside funding in addition to self-funding.
How to evaluate which financing option will lower your cost of debt
Compare financing offers by looking at how much you will repay, when payments are due, and which assets or guarantees are tied to the agreement.
Before choosing an offer, note these five inputs:
- Total dollar cost. The full amount you will repay, including interest, fees, and fixed borrowing costs.
- Repayment cadence. How often payments are collected, such as daily, weekly, monthly, or as a percentage of sales.
- Term length. How long repayment lasts and how that affects the total amount paid.
- Collateral or guarantee requirements. Whether business assets, personal assets, or a personal guarantee are required.
- Cash-flow timing. Whether repayment lines up with when revenue comes in.
A simple financing comparison can start with the business need:
| Business need | Financing option to consider |
|---|---|
| One-time growth investment | Term loan or SBA 7(a) loan |
| Short-term cash-flow gap | Business line of credit |
| Unexpected expense | Short-term loan or line of credit |
| Inventory purchase | Inventory financing, line of credit, or sales-based financing |
| Recurring working-capital needs | Revolving line of credit or flexible funding option |
SBA 7(a) loans are one example of a traditional financing model. The SBA says 7(a) loans can be used for working capital, equipment, supplies, real estate, and business debt refinancing.
Eligibility is based in part on creditworthiness and the ability to repay, and most 7(a) term loans are repaid through monthly principal and interest payments from business cash flow.
Shopify Capital
Benefits of capital loans and cash advances
When your business needs an injection of capital to help it grow, there’s Shopify Capital. Eligible store owners may receive financing offers in the Finance section of their Shopify admin.
From there, they can apply online in just a few clicks. If approved, funds will be deposited in their linked bank accounts in as soon as two days.
Payments are made automatically as a percentage of daily sales, plus borrowing fees, so store owners enjoy ease of use and peace of mind that they’re repaying financing as they grow.
Examples of how businesses use capital loans and cash advances
Larger retailers use capital loans and cash advances to make investments into their operations to help them grow. Shopify store owners can do the same through Capital.
Retailers often invest in initiatives like launching new products, expanding into new markets, or making large new purchases of stock, inventory, and supplies to ramp up production.
Types of businesses that choose capital loans and cash advances
High-growth businesses wanting to increase predictable cash flow can use loans and cash advances to make large investments and realize their potential. This capital can be the catalyst for your businesses to scale easily.
Use cost of debt and cash flow to help choose the right financing option
Cost of debt can narrow the financing options that make sense for your business. Cash flow can show whether repayment schedules align with how money moves through the business.
That balance is important for store owners. Shopify fourth-quarter 2025 Survey of store owners** found 34% of them cited ensuring stable cash flow as their second business goal.
Cost of debt FAQ
Is cost of debt higher than equity?
Typically, cost of debt is lower than cost of equity because interest on a loan may be tax-deductible, while equity investors may expect higher returns. That difference is one reason businesses compare debt financing versus equity financing before choosing how to raise money.
What is an example of cost of debt?
The cost of debt is what you pay to borrow money. A common example is annual percentage rate, which is calculated using a loan’s interest rate and fees associated with taking out that loan.
What is weighted average cost of debt?
Weighted average cost of debt is the average rate a business pays across all debt. Each debt balance is weighed based on the amount owed, so larger balances carry more weight in the final rate.
What is the difference between cost of debt and WACC?
It’s common for businesses to use a combination of debt and equity to finance their business. Weighted average cost of capital, or WACC, uses cost of debt and cost of equity to help businesses calculate an average cost for financing their operations. Cost of debt is just one component of WACC.
What is the after-tax cost of debt formula?
The after-tax cost of debt formula is: pre-tax cost of debt x (1 − tax rate). A 7% pre-tax cost of debt and a 12% tax rate equals an after-tax cost of debt of 6.16%.
*Shopify Capital loans must be paid back within 18 months, and two minimum repayments must be made within the first two six-month periods. Store owners must pay a minimum of 30% of the total payment amount within six months of receiving funding and an additional 30% within 12 months of receiving funding.
This article is focused on industry standards and descriptions are not specific to Shopify’s financial suite of products. To understand the features of Shopify’s lending products, please visit shopify.com/lending.
Available in select countries. Offers to apply do not guarantee financing. All financing through Shopify Lending, including Shopify Capital products, is issued by WebBank in the United States.
**Based on a 2025 survey of 500 Shopify merchants conducted in English across Australia, Canada, the United Kingdom, Ireland, New Zealand, and the United States. Respondents were established merchants with two or more years on the platform. Results reflect the experiences of this specific sample and may not be representative of all merchants.
