If you won the lottery, would you choose to be paid in a lump sum today or in installments over time?
Say, for example, that the lottery is worth $73 million. You can choose to receive $39 million today or $73 million paid annually over 26 years. Both options are subject to a 34 percent tax when money is received, which means that the after tax dollar amount is 66 percent of the total lottery, or 66 cents for each dollar. (100% - 34% tax = 66%).
The value of choosing the money today is: $39 million x .66 = $25,740,000.
The value of the money over time is: ($73 million/26 years) x .66 = 1,853,077 per year, or $48.18 million.
So, the question is: $25.74 million now or $48.18 million over time?
But it's not that simple. You also have to figure the opportunity cost of taking the money later vs. now.
If you put the lump sum payment ($25.74 million) into a tax free interestbearing government bond with a 5 percent return, over 26 years you would net $91 million. Compare this to the $48.18 million if you took the money over time.
The same principles apply to purchasing equipment for your solid waste business. Equipment can be expensive and deciding how to pay for it takes careful thought and planning. Is it better to pay with cash and own the equipment free and clear or is it better to invest your cash in your business?
Before you choose a purchasing option, consider the time value of money, your tax position, your liquidity needs and the cost of borrowing. [See "What Does It All Mean?" page 241]. Once you have determined these you can choose the financing product that is best for your company. Here are some guidelines to help in your decision.
I Pay Cash "I pay cash" is a common statement. Paying with cash is believed to have several benefits. You have no payments, and you don't pay interest. However, before you pay with cash, consider the time value of money. What will the dollar that you spend on equipment today be worth five years from now?
Spending cash on depreciating assets, such as containers, computers or scales is not necessarily the wisest option. Excess cash may generate a better return if it is invested in marketing, sales or other areas.
Scott Fitzmorris of Collection Services Inc., Cary, N.C., says keeping cash onhand is like carrying insurance.
"Most companies spend cash for equipment without weighing the other options," he says. "Sure, it costs money to borrow money, but isn't it worth it? We pay for insurance that we may never use and we all agree that it's worth the money. The way I see it, cash is the best insurance money can buy. Liquidity enables companies to grow, build and repair when necessary."
Financing Options To say that finance companies are all alike is like saying all solid waste companies are the same. On the surface they do the same thing haul garbage. But anyone who has been in the industry at least a week knows that isn't true. The same applies to finance companies.
Financing services are offered by banks, captive/single source leasing companies and third-party leasing companies, each offering different products and services with strengths and weaknesses.
Banks. If your company has a strong cash position, borrowing from a bank may be the best option. Your bank probably has given you an open approval already.
The downside is that banks often have a rigid lending policy. A loan committee may need to approve your application, slowing down the response time for your request.
A bank generally is a collateral lender, meaning that a bank weighs the estimated future value of the equipment into its decision. A bank may be more likely to approve a loan for a rear loader than for onboard scales or tracking software.
Additionally, banks often require a complete finance package, compensating balances, financial statements, tax returns, personal financial statements, down payments, etc. to approve a loan. Businesses that are high insurance risks or industries that have a high rate of failure are unlikely to be approved.
The upside is that banks usually allow for early repayment of loans. They also may offer customer service or rate incentives for businesses that have deposit and loan accounts with them.
Captive/single source leasing companies. These types of lenders use their own money to finance a lease. They may allow the equipment vendor to sign a recourse agreement, meaning the vendor guarantees the lease on your behalf. Typically, this requires a large down payment. These leasing companies also may have a built-in re-marketing program available to help you sell your equipment at lease end with a higher residual, resulting in a lower monthly payment. However, if the equipment sells for less than your agreed upon residual, you may be required to pay the difference.
Additionally, these companies may allow vendors to participate in a buy down program. In effect the leasing company will buy the equipment from the vendor for less than the price you are quoted. To make sure you are getting the best deal, be sure to ask for the principle and payment amount.
The downside to using a captive leasing company is that it may have a limited credit approval range and may be tied to one vendor or dealer, which may limit the brand of equipment you can lease.
Third party leasing companies. These are independent agents that evaluate different lenders to determine which one is right for your needs. They act as a brokers to find you a lease lender. A third-party leasing company will require only a credit application on transactions less than $75,000 and a full financial package on more expensive leases. On transactions less than $75,000, a broker usually can have an answer in less than 48 hours. Additionally, there may be no need for a down payment.
Third-party leasing companies can structure a deal to meet your company's specific needs, such as seasonal payments or a 90-day deferred plan [See "To Lease or to Buy" page 240].
As a credit lender, a third-party leasing company is less likely to weigh the equipment type purchased into the approval decision. These companies typically specialize in one or two industries and often become experts in the equipment and its financing.
Making the Decision Before you choose which funding vehicle is best for you, do your homework. If owning equipment that may become obsolete is a concern, you may be better served with an upgrade lease. If cash flow is a problem and the equipment has a long active life, then a long-term finance lease with a predetermined purchase may give you the lowest monthly payment.
Ultimately, you should review all your options before making an educated buying decision.