Deposits are an under-recognized interest-free loan 

Placing a deposit on a high-ticket item is commonplace. We use deposits to confirm our interest in a particular good/service and/or protect it from acquisition by another (? competing) customer. These benefits are obvious and well known; less obvious is that deposits are interest-free loans. Let's take a dive into deposits and understand how these interest-free loans can help/hurt a healthcare entrepreneur.

Our case

Here is a typical case that a healthcare entrepreneur is likely to face.

Our healthcare entrepreneur needs to purchase equipment. She finds a supplier and agrees on the price ($X), but needs some modifications made to it in order to best suit her needs. The supplier requests/demands a deposit so he can begin the work - he typically collects 10% of the total price upfront ($0.1X). The work takes 4 months to complete and in that time, the equipment remains with the supplier. At the end of 4 months, the remaining 90% is expected in order to turn possession of the modified equipment to the entrepreneur.

Asset control and opportunity costs

At the time our entrepreneur makes the deposit, the supplier controls $ 1.1X of her assets: $ 1X in the form of the equipment and $ 0.1X in cash (the deposit). He will control this amount of her assets for 4 months - a degree of control that really dampens her ability to earn revenue through her venture. This lack of control over $ 1.1X of her assets is an opportunity cost to her. Let's deconstruct the source(s) of opportunity costs she must endure. 

What is her opportunity cost for not having possession of her equipment? One can make an argument that the cost is $0.00 because the piece of equipment, as it currently exists, is not ready/capable of generating revenue for the entrepreneur. If she had possession of the un-modified equipment, she would not be able to generate revenue. Thus, not having control of the un-modified equipment would not affect her revenue.

What is her opportunity cost for not having the deposit? Unlike the piece of equipment, the deposit of $ 0.1X is capable of generating revenue if she had control of it. So what would the cost be of not having possession of the deposit?

Opportunity cost of the deposit

The opportunity cost of her deposit = her next best option for using the $ 0.1X to generate revenue. One option would be to invest $ 0.1X for 4 months. Let's say the entrepreneur selects an extremely safe vehicle in which to invest her deposit: a savings account. In order to calculate the return on a $ 0.1X investment over 4 months, we need to know:

1. the stated annual interest rate, and

2. the compounding frequency: monthly, quarterly, or something else

We won't do the math here: we've reviewed it in "Interest rate alphabet soup: APY, APR, Coupon, Yields, SAIR, EAR". The calculated value of her return over 4 months is her opportunity cost for making the deposit.

Deposit = interest-free loan

So, we've established two points in this transaction:

1. the supplier has incurred a liability (deferred revenue), and

2. the entrepreneur has an opportunity cost associated with making the deposit

If the entrepreneur doesn't charge the opportunity cost to the supplier, she has provided him with an interest-free loan. Indeed, if the supplier needs only a portion of the $ 0.1X to pay his employees and purchase materials for the modification, he can invest the balance and reap even greater benefits -- all at no cost to himself.

There you have it. A deposit is a form of an interest-free loan. If you're an entrepreneurBut it’s unavoidable? Who does not require a deposit? Can physician ask for a deposit from a patient until an insurance company pays the service? receiving deposits, you may want to take advantage of the interest-free condition and invest a portion of the deposit to increase returns. If you're an entrepeneur that makes deposits, you may want to calculate and factor your opportunity costs into the transaction. 

Questions

• Are deposits unavoidable? Who does not require a deposit? Can a physician ask for a deposit from a patient until an insurance company pays the service?

  • Great question. If you're an entrepreneur that needs to make a deposit, consider negotiating a lower final price based on the interest you sacrifice. Alternatively, use the fact that you need interest on your deposit to push your vendor to complete the project sooner (or supply the asset quicker).

  • I'm unaware of physicians in the US asking patients to make a deposit above their copay until their insurance company reimburses the physician. It's an idea worth exploring if the antithesis isn't already codified.