In today's business world, acquiring equipment can frustrate even the most financially-savvy owner.
Not only does the equipment have to meet certain job requirements, but choosing a manufacturer and securing financing can be confusing.
Equipment can be acquired four ways: rent, pay cash, get a bank loan or lease. Each method has distinct advantages and disadvantages.
* Equipment rental allows you to use the equipment without the disadvantages of direct ownership, such as maintenance or repairs. This strategy is good for short-term projects, but doesn't make sense for a company that will use the equipment on an ongoing basis, because rental payments are twice as much as bank installment payments and lease payments.
* Cash transactions can be good if the company is in a strong cash position. However, the down side to this method is that cash re-serves are diminished, leaving less capital in reserve for growth or available for an emergency.
* Bank loans in today's economy can be an attractive form of financing because of low interest rates. However, banks often require a lot of information such as financial statements, tax returns and, sometimes, personal financial statements of the principles involved.
Banks look differently at used equipment. Based on the equipment's age and condition, a bank may chose to finance a portion of the deal. In many cases, this is the loan value of the equipment which will only account for approximately 75 percent of the price.
In this scenario, the company would have to pay the balance - not a good position for companies with low liquidity.
Banks also offer lines of credit to aid companies with short-term financing issues. The best use of this tactic is for expansion or when a company needs a short-term cash infusion. It is best not to use a bank line of credit for any equipment-related projects that represent longer term investments.
* Leasing is the fourth way equipment can be ac-quired. Capital conservation, flexible terms and 100 percent financing are just a few of leasing's benefits. Currently, the leasing demand is high, as evidenced by the number of companies choosing to lease equipment. In addition, leasing provides a tax break which compliments business cash flow and seasonal slumps.
Tax Benefits Leasing, when set up properly, will allow the lessee to expense 100 percent of his payment every month of the term.
And the payment to the lender is made with pre-tax dollars. For example, let's say your company grosses $5,000 a month, and you are financing a $36,000 piece with monthly lease payments of $843. Most companies are taxed at a rate of approximately 30 percent, so $1,500 of the $5,000 profit goes to pay Uncle Sam.
In the case of a lease, the $843 paid to the lender can be deducted from the $5,000, leaving a taxable amount of $4,157. Take the same tax rate of 30 percent, and the taxes owed drop from $1,500 to $1,247. A savings of $253 is realized because the lease payment is expensed.
To take this one step further, multiply the effective monthly payment by the lease's term. In this example, that would be $590 times 60 months or $35,400. Notice, this is less than the original cost of $36,000.
Help For Low Liquidity Acquiring assets through leasing becomes even more desirable as equipment costs rise. For affordability, many companies choose to acquire more sophisticated equipment through a lease rather than a purchase.
Generally, leasing companies require lower down payments than other financial institutions. For example, the typical lease transactions require one or two advance lease payments as a security deposit. This represents approximately two percent to five percent down.
Also, all the incidental costs associated with the transaction - such as sales tax, installation and other soft costs - can be rolled into the financing, freeing up even more cash for non-equipment related activities.
Leasing also allows a company to improve cash forecasting. In a lease, the lessee uses the equipment for a specific period of time and, in return, pays a periodic rental or lease payment.
A lease contract specifies the future cost of the equipment. In the case of a fair market value lease, the price at the end of the lease is negotiated between the lessee and the lessor.
Since the purchase option is determined at the end of the lease term, the company can decide if the equipment is outdated at the end of the lease and return it or opt to purchase.
This allows for a more accurate evaluation of the equipment at the term's end as to its condition and/or technological status in the industry.
Most leasing companies offer specialized programs that can be tailored for an individual company's needs. The three most common special programs offered by leasing companies today include:
* Deferred lease programs. If a company is experiencing some cash flow problems and needs three to six months to have the equipment start generating revenue, then a deferred payment plan is an aven-ue they should consider.
* Seasonal lease programs. Seasonal slow periods often affect a company's ability to service existing debt - most common in cold weather climates.
Lease payments that are spread out over the year's busier nine months make it easier for the company to handle the debt load.
* Step payment plans. These are flexible lease plans. Step up programs allow lessees to pay 50 percent of the lease payment for the first year and then resume normal payments for the term's remainder.
Payments in this case really are not deferred but rather are reduced significantly for the first year, giving the company the necessary breathing room it may need to get a project off the ground or simply delay full payment until its cash flow can support the debt.
Leasing, rental, cash purchases and banks all can help your company acquire the equipment you need. Each has distinct advantages and disadvantages, but the mistake most companies make when looking to finance is not considering all facets of their business.
Everything from a project's length to business growth plans should be looked at prior to deciding how equipment will be financed.