Smart borrowers consider ROI, tax implications when adding equipment
Now that 2023 is in full swing, I thought it would be a good idea to share some of the best questions that I get from potential clients who are looking to arrange equipment funding.
Before I get to the best questions, I need to start with the one I get asked first most often: what is the rate or cost of funds? This has become an even larger concern for manufacturers because we have been living in an environment that has seen almost monthly rate increases since the spring of 2022.
Normally, if rate is what a customer is leading with, then I immediately know there is work to be done because it is not the best place to start.
Let me preface, as seller of a service, I totally understand that the lowest cost of funds is important, and if I am shopping for anything, I do not behave any differently in cases where all things are equal. With that said, as any manufacturer knows, rarely if ever are all things equal, and quoting a job the cheapest to secure the purchase order isn’t always a win.
Not Like Mortgages
Since my business is 100 per cent referral and repeat, any potential client received my name from an equipment seller or someone who has done business with me in the past. This also means when their first question is about rate there is no frame of reference and their expectations are based upon previous borrowing experiences, usually a mortgage or a car.
When it comes to rates, whether you are talking to your banker or a leasing company, they are predicated on the same two things: the transaction size and the applicant’s credit profile.
Now let me bring you behind the curtain: a bank will always have the cheapest cost of funding, without question. There are several reasons for this, but simply put, they have a very low cost of funds. A bank transaction also is highly secured, so there is very little risk of loss.
In the case of a mortgage, the bank is in an equity position from Day 1 because the amount lent is less than the value of the asset. Most institutions will not lend more than 70 to 75 per cent of the purchase price, but when they do, it will be at very cheap rates. The reasoning is quite simple. First, a mortgage is a very long-term transaction—20 years or more—and because interest is compounded, banks make a substantial profit even at low interest rates.
When it comes to a car lease where the dealer arranges the lease with the lender, normally a bank, they can offer something attractive because the rate is subsidized by the manufacturer. This becomes obvious when the cash purchase price for the same car includes discounts that are not included when the car is priced for the lease.
It also should be noted that with any lease, regardless of the asset, the rate is fixed for the entire duration of the term. This means once the lease is booked, the payment and, in turn the rate, is fixed. Regardless of what happens within the marketplace, particularly if rates continue to rise, there is no change to the monthly payment or the rate being charged.
Good Question
I immediately know I am talking to a forward-thinking client when the discussion starts with a question about payment and term.
When leasing, you are taking rate out of the conversation and evaluating the transaction based upon monthly lease expense against revenue. In other words, can the in-house work or the just-landed contract generate enough income to justify adding a new machine to the shop floor?
The reality is if the lease payment is a small percentage of the monthly revenue, then adding new equipment is a no-brainer.
For example, a $200,000 machine tool would work out to cost a manufacturer approximately $4,100 per month over five years but it should generate a minimum of $15,000 per month in revenue.
This same smart client also realizes that customers rarely pay on time, so it is critical to have money in the bank to operate and is in full agreement when I tell them not to tie up valuable cash or operating lines with expenditures that can be leased.
Most people assume equipment leasing is for the business owner who can’t write a cheque. However, my best clients are successful manufacturers who have plenty of liquidity but choose to invest their money in places where they will get the best rate of return, which for them is normally product development.
Good For Taxes
Another intelligent question I often receive is related to utilizing leasing as a tax-friendly option.
Although I am not an accountant, from a taxation standpoint, leasing can potentially add equipment to the shop floor and profit to the bottom line while saving tax dollars.
Most of my clients write off their payment as an expense no different than tooling, material, and wages. This makes the rate conversation even less important because if the payment becomes a writeoff, then the taxes saved are always greater than the interest charged.
This also should be considered when configuring a machine. I have clients who understand they need a funding source for the equipment but still insist on using cash for accessories, whether it is a rotary table for a machining centre, toolholders, a robot for loading/unloading, or even to upgrade CAD/CAM software.
As I mentioned earlier, rates are based on both the applicant’s credit profile and the transaction size, which means the larger the transaction, the better the rate. Whenever a large transaction is being considered, it is of the utmost importance to have a conversation with your accountant or financial advisor before proceeding, particularly if how the transaction is handled, from a taxation perspective, is the main factor in the decision-making process.
The reality is when it comes to rate, the typical lease varies from what is offered by a bank in many ways, the most relevant today being the fixed rate and the limited amount security. Because it is a riskier transaction than one typically found at the bank, it also is not priced identically. Therefore, it is important to move beyond cost of funds when evaluating whether it makes sense to proceed.
Ken Hurwitz is vice-president of Equilease Corp., 416-499-2449, ken@equilease.com, www.equilease.com.
Article From: https://www.canadianmetalworking.com/canadianmetalworking/blog/management/machine-tool-financing-dont-fixate-on-rate