The growth of your business depends on having the right equipment. As the old saying goes, tools and equipment should always be treated like good friends; treat them well and they’ll always be there for you.
While purchasing the right equipment may sound easy, there are many aspects of the long term buyer’s journey that should be investigated prior to signing on the dotted line. Calculating and achieving a good Return on Investment (ROI) on your equipment is just as important as being able to dive into a new arena of business.
Here are the core areas to consider when making a decision to invest in assets that can accelerate the growth of your business.
Leasing vs Financing
Arguably, the first question you should ask yourself after deciding to move forward with your expansion plans. You need the right equipment, so how should you approach the financial equation of making it a profitable endeavor in terms of a good ROI?
Leasing and financing loans both offer substantial pros and cons, depending on the purchasing power of your company, and your expected benefits associated with the costs.
Let’s put this into perspective:
Lease payments can act as rental payments through an operating lease, or as repayments with interest through a capital lease. The leasing company in turn owns the equipment you choose to purchase, and your business would be responsible for paying the equivalent to rental payments – most leasing companies also provide the option to purchase the equipment outright at the end of the term.
With an operating lease, your company will make, in essence, rental payments and you can write-off the full portion of your lease payments as an expense. With a capital lease on the other hand, you’ll assume liability of ownership for accounting purposes, but you can likely deduct the full amount of your lease payments as well.
As a bonus, no down payment is usually required, and leases typically require no collateral because the value of the equipment itself serves to satisfy that need by the leasing agent. Leasing also usually preserves your company’s line of credit for other opportunities.
Loans put the equipment directly under the care and ownership of the company purchasing the equipment. Payments are usually set up as repayments with interest that reduce the principal amount of the total borrowed. Loans usually require a down payment, as your company will likely finance the remaining equipment costs.
Collateral may be needed, but you’re able to claim tax deductions for the interest paid on your loan. You’ll be able to write-off the annual amortization based on the capital cost allowance of the equipment. Because you own the equipment, your company will be left with the equipment to bear the brunt of obsolete technologies and depreciation.
Both options keep the cash flow of your business open and allow you to maintain a level of financial flexibility. If you find yourself in an industry where the equipment will require constant maintenance, a lease agreement is a big benefit. However, the ability to deduct tax from a loan agreement over the long run can be appealing to certain businesses as well.
Depreciation and Recouping Costs
Any piece of equipment that is expected to last longer than one fixed year is usually considered a fixed asset. Accountants and financial advisors will want to know about the perceived lifespan of the equipment in question, and how long it will be before the equipment needs to be replaced.
Understanding why depreciation is important helps businesses match their expenses to annual revenue. This is especially important for those who choose a loan over a lease, as the equipment will eventually become the property of the company.
There are a number of ways to calculate equipment deprecation. Methods based on time can include straight-line, declining balance, and sum-of-the-year’s depreciation. As a default methodology, straight-line depreciation is used by most companies. It’s easy to calculate, and is used when no unusual patterns alter the use of the equipment – like a fleet of consistently used rental cars, or heavy construction machinery for example. These types of equipment will likely be used in much the same fashion over the course of their lifespans. Top put it simply, deprecation must be accounted for as an expenditure.
Understanding depreciation is vastly important in achieving a good ROI because depreciation is a direct expense to your company. Things you can do to achieve a greater return on total assets include increasing service intervals and therefore the total useful lifespan of your equipment, and investing in the right equipment.
Overhead costs must always be reduced where they can be reduced, but buying the cheaper product doesn’t always mean you’ll see savings – a cheaper piece will require more time and resources for service and repairs. Picking the more durable, reliable piece – while more expensive out of the gate – will inevitably save you money in the long run and help to reduce equipment depreciation estimates.
The Breaking Point
The Harvard Business Review stated in a recent financial analysis of common mistakes made when calculating ROI, that “profit is not the same thing as cash.”
Calculated ROI is based on understanding all of your expenses and making financial decisions based on the long run, as short term purchases only enable your business to potentially attain these projections.
For example, initial investments are always made in cash – with returns measured in terms of profit or revenue. But, cash flow is more important, as a business must account for money moving in and out of itself to realize its true potential for profit.
The breaking point here, is assessing and accounting for investments in equipment and their expenses – determine the minimum return required by your business and evaluate your investments. The investment being: the time you take to calculate and investigate the potential for a decent ROI.
While these are only basic steps to consider when beginning your equipment purchasing plans, there’s a lot more to getting this complex equation correct. It’s important to analyze your opportunities and seek guidance from a financing professional that intimately knows the industry you serve, understands your growth goals, and uncovers an efficient execution plan to achieve the end result.