Cheap finance can make a weak investment look affordable. Expensive finance can make a strong investment look unattractive. A supplier offering “no deposit, repayments lower than your savings” can make almost anything look sensible on a monthly cash basis. Neither conclusion is necessarily right, because two different decisions have been blended together: whether the investment itself creates value, and how it should be paid for.
A related confusion concerns the method used to judge an investment. Return on investment, payback, net present value, cost-benefit analysis and cost-effectiveness are often treated as interchangeable. They are not. Each answers a different question, and using the wrong one can produce an accurate answer to a question nobody needed to ask. And whatever method is used, analysis can quietly turn into advocacy when it is prepared to support a choice already made.
This article explains how to separate the investment decision from the financing decision, how to choose the right test for the question at hand, and how to keep analysis honest enough that it could actually say no. It is general information; talk to your accountant or financial adviser before making significant investment or financing decisions.
Three separate questions
Corporate finance usually separates three questions:
- The investment question: should the business invest in this at all?
- The financing question: how should the investment be paid for: cash, loan, lease, equity, a partner or supplier finance?
- The working capital question: can the business fund its day-to-day operations while the investment develops?
When these are combined into one number, such as “monthly repayments are less than monthly savings”, it becomes hard to see where value is actually being created or lost.
Finance writers Tom Arnold and Terry Nixon, in a 2011 chapter on investment valuation, discuss how the definition of cash flow, the way a project is financed, tax effects and the discount rate all interact. Their technical discussion matters to specialists, but the practical principle is simple: do not let financing effects hide the underlying economics of the investment.
Judge the investment before the funding
First ask whether the investment creates value on its own, before any financing. Does it generate enough incremental cash, over its life, to justify the money committed, at a rate that reflects its risk? The what the NPV spreadsheet hides article explains how to test this.
Then ask how best to fund it. A valuable investment may be too large for the current balance sheet. Options include staging it, leasing, bringing in a partner, borrowing, using supplier terms or deferring. Rejecting a good opportunity because one form of funding is expensive may be the wrong response. Equally, accepting a poor one because finance is cheap is a mistake.
Common errors:
- Cheap finance makes it good. Finance can improve affordability. It cannot create demand, productivity or relevance.
- Expensive finance makes it bad. The investment may be sound but need a different funding structure.
- Mixing financing into operating results. If interest, repayments and tax effects are blended inconsistently, different options are compared on different bases.
- Treating debt as free. Borrowing creates fixed obligations and reduces flexibility. Equity dilutes ownership and future gains. Each has costs beyond its headline rate.
Financing changes risk, scale and flexibility
Financing is not neutral. Debt creates fixed repayments regardless of how the investment performs. A lease can preserve cash but limit control of the asset. A partner can bring capability as well as money, along with shared decision-making. Financing can even change the opportunity itself, by allowing a larger investment than the business could otherwise afford, which also increases the exposure if things go wrong.
Unused borrowing capacity also has value. A business that borrows to the limit for today’s investment may be unable to respond to tomorrow’s opportunity or survive a downturn. Present three things separately when making a significant decision:
- the value created by the investment itself;
- the cost or benefit created by the financing;
- the effect on the business’s resilience and future options.
Choose the right test for the question
The Australian Government’s Handbook of Cost-Benefit Analysis, published in 2006, distinguishes three approaches, each suited to a different question:
| Question | Method | Strength | Limitation |
|---|---|---|---|
| Is this financially worthwhile and affordable for our business? | Financial appraisal | Clear view of the business’s own cash | Leaves out effects on others |
| Does this create net value for the wider community? | Cost-benefit analysis | Includes effects on others and non-market effects | Valuing some effects is difficult; can hide who gains and loses |
| Which option achieves a defined outcome at least cost? | Cost-effectiveness analysis | Works where benefits are best measured in physical terms | Does not say whether the outcome is worth its total cost |
For most private business decisions, financial appraisal is the main test. But other lenses help in particular situations:
- Cost-effectiveness suits choices where the outcome is fixed, such as meeting a safety requirement or cutting a given amount of energy use, and the question is which option achieves it most cheaply.
- Broader cost-benefit thinking matters when a decision has significant effects on others, such as neighbours, customers or the environment, or when a business is seeking public funding or approval and must show wider value.
Large decisions may need more than one lens. A manufacturer’s energy project might need a financial appraisal for its own economics and a separate account of its environmental effects. Use each method for the question it answers, then bring the evidence together when deciding, rather than blending everything into one opaque score. The not every return is financial article covers value that does not appear in cash flows.
When analysis becomes advocacy
Analysis can be prepared to support a decision already made. Research by I Putu Sudiana in 2010, studying cost-benefit analysis in two Australian Government departments, found that managers regarded it as useful in principle but that in practice it was sometimes used to support decisions rather than to make them, with concerns about transparency and internal capability. The study was limited, but the risk applies to any business.
Advocacy usually enters quietly, not through dishonesty:
- Weak alternatives. The preferred option is compared with “do nothing” while realistic alternatives, such as a smaller version, a staged approach or a process change, are left out.
- Uneven depth. The preferred option is analysed in detail; alternatives are described in a sentence.
- Asymmetric assumptions. Benefits are “expected”; risks are “conservative”.
- Selective quantification. Easy-to-measure benefits are valued precisely, while harder costs, such as disruption or risk, are mentioned in passing.
- No capacity to challenge. Nobody in the business can question the model, especially when a supplier or consultant prepared it.
The most useful single test is: could this analysis produce a “no”? If every path leads to approval, it is not functioning as analysis.
Keeping analysis honest
| Test | Question |
|---|---|
| Framing | Could someone without a stake in the proposal challenge how the problem is defined? |
| Alternatives | Have realistic alternatives been analysed to similar depth? |
| Assumptions | Can each major assumption be traced to evidence and an owner? |
| Boundaries | Are important unquantified effects visible? |
| Sensitivity | Can decision-makers see what would change the answer? |
| Capability | Is there someone who can genuinely question the method? |
| Accountability | If the decision departs from the analysis, is the reason recorded? |
Departing from the analysis can be entirely legitimate: strategy, ethics, safety or operational judgement may outweigh a narrow financial result. The point is to say so openly rather than hide the judgement inside the numbers.
Watch the working capital
The third question, working capital, is easy to forget. An investment that adds sales may also add stock, longer customer payment terms and more cash tied up before customers pay. A business can make a sound investment, fund it sensibly and still run short of cash because the growth it creates needs more working capital than expected. Include working capital in the investment’s cash flows, and check that the business can fund it through the period before benefits arrive.
A worked example
This is an illustration. A regional food business is offered a $250,000 solar and battery system by a supplier, with finance at 4% over ten years. The supplier’s proposal shows savings of $36,000 a year and loan repayments of about $30,800 a year: “cash positive from day one”.
The owner separates the two decisions.
The investment first. The owner’s accountant checks the savings against the business’s actual electricity use and tariffs and estimates about $32,000 a year. The system needs about $3,000 a year in maintenance and an inverter replacement of about $25,000 in year ten. Over fifteen years at an 8% discount rate, the investment’s NPV is about −$13,000; at 6% it is about +$18,000. On the supplier’s figures it would have been about +$58,000. The investment is marginal, and its value depends on the discount rate and the savings assumption.
The financing second. On realistic figures, net savings of about $29,000 a year are slightly less than the loan repayments of about $30,800. The “cash positive from day one” claim depended on optimistic savings and left out maintenance.
The right test. The owner also wants to reduce the business’s emissions, partly because two major customers are asking suppliers for emissions information. For that goal, the relevant question is cost-effectiveness: which option cuts the most emissions per dollar? A refrigeration controls upgrade costing about $40,000 turns out to reduce energy use significantly with a short payback.
The owner decides to do the refrigeration upgrade first, then reconsider a smaller solar system sized to daytime use, with its economics assessed on its own before any financing offer is compared. The decision record states that emissions reduction is a goal in its own right, and what the business is prepared to pay for it.
How this applies to a small Australian business
Small businesses are often offered investments and finance together, packaged by the supplier. Practical steps:
- Judge the investment on its own before looking at the financing.
- Check supplier savings estimates against your own data.
- Compare financing options separately: cash, loan, lease and supplier finance.
- Keep some borrowing capacity for future needs.
- Choose the test that fits the question: financial appraisal, cost-effectiveness or broader cost-benefit thinking.
- Analyse realistic alternatives to similar depth.
- Ask whether the analysis could say no.
- Talk to your accountant about tax treatment, financing costs and cash flow before committing.
Signals worth watching
- Offers that combine an investment and its financing into one monthly figure.
- “Cash positive from day one” claims.
- Business cases comparing the preferred option only with doing nothing.
- Supplier-prepared analysis that nobody in the business can question.
- Benefits measured precisely and costs described vaguely.
- Every analysis recommending approval.
Common mistakes
- Letting cheap finance justify a weak investment.
- Rejecting a good investment because one funding option is expensive.
- Using the wrong appraisal method for the question.
- Treating debt as free.
- Analysing alternatives superficially.
- Hiding judgement inside the numbers.
Frequently asked questions
Is supplier finance a bad idea? Not necessarily. It may be convenient and competitive. Just compare it with other options after confirming the investment itself makes sense.
Should we always pay cash if we can? Not always. Keeping cash can preserve flexibility for other opportunities or difficult periods. Compare the cost of finance with the value of keeping cash available.
When should a small business think about wider community effects? When a decision significantly affects neighbours, customers or the environment, when you are seeking public funding or approval, or when customers expect information about your impacts.
What is a realistic alternative? An option that could genuinely meet the need: a smaller version, a staged approach, a different technology, a process change or a different supplier. “Do nothing” alone is rarely enough.
Who should prepare the analysis? Ideally someone who does not benefit from the decision, or at least with review by someone who does not. Supplier analysis is a useful input, not a substitute.
How do we compare a lease with a loan? Compare the total cost of each in today’s dollars over the same period, including fees, maintenance obligations, residual payments and what happens at the end. Also compare flexibility: what each option lets you do if needs change. Your accountant can help with tax effects.
Questions to ask
- Does this investment create value before financing?
- What does the financing add, cost or risk?
- Which method fits the question we are actually asking?
- Have we analysed realistic alternatives to similar depth?
- Could this analysis have produced a “no”?
- What borrowing capacity will we have left afterwards?
Bringing it together
Decide whether an investment creates value before deciding how to fund it, and present the investment, the financing and the effect on resilience separately. Choose an appraisal method that answers the question you are asking: financial appraisal for your own economics, cost-effectiveness when the outcome is fixed, broader cost-benefit thinking when effects on others matter. Keep analysis honest by comparing realistic alternatives, tracing assumptions and asking whether it could say no. A good funding deal cannot rescue a poor investment, and a good investment deserves a funding structure that fits it.
Source: KEVOS notes, drawing on T. Arnold and T. Nixon (2011) on investment value and financing, the Australian Government’s Handbook of Cost-Benefit Analysis (2006), and I. P. Sudiana’s 2010 study of cost-benefit analysis in public decision-making. Examples and figures in this article are illustrations. This article is general information, not financial advice.
