Making Equipment Financing Decisions for Business
Businesses grow and as they do so they need more resources. This can frequently include the need for more plant, machinery and equipment. The problem is that often these items are very expensive and it is not possible to finance them out of cash-flow. So the business will aim to raise equipment financing at a cost and level of risk that the management can willingly live with. The costs are of course the repayments and the biggest risk here being that the business may not be able to service the debt consequently being forced into insolvency.
Generally speaking, there are about 5 main channels through which a company may get the funding it requires to raise sufficient capital. These are:
- Acquiring credit from suppliers
- Obtaining a loan from a bank
- Issue stock
- Issue bonds
- Obtaining a financing lease
Approaching a supplier for credit is one of the easiest ways through which a company can obtain funding. With this option, a company may acquire services and goods and are given a specified period of time to pay for them. If the company requires more credit from the said supplier, their financial controllers can negotiate for longer credit terms. Payment terms may also be stretched. This option works well as the creditors are keen on ensuring that their customer is still operational because if the customer becomes insolvent, they would lose their money.
Another reliable channel for getting funds is through approaching a bank. If the company has a revolving credit line with a bank, it can draw down, within its credit limit, as money is required and pay back when the business makes more money. This credit is usually guaranteed by the firm’s assets. However, if the business runs into trouble, paying back the money may become a problem leading to bankruptcy.
Bonds usually have a principal maturity and fixed interest rates on the contractual payments. Here, the risk lies on the company’s owners if they are not serviced. In this case, principle bond owners could easily exchange them, attaining ownership of the firm and eventually ousting the rightful owners. They tend to be an option only available to larger companies.
These have a non-contractual, non-tax deductible payment system. Stocks represent some form of ownership of the business and all its assets. At the same time, stock shares can be offered to raise capital at the existing shareholder’s expense. Here, new shareholders get to share ownership interest on an equal per-share basis with the existing shareholders. This dilutes the interests of the existing shareholders. However, the cost of going to market is extremely high both before and after the event so it is not a possibility for most companies.
Instead of opting to buy equipment, most companies will opt to get equipment lease financing for it. Things like heavy equipment, computers and cars can be financed for long or short periods.
A short period lease is referred to as the operating lease. The equipment is owned by the leasing company rather than the business itself. At the end of the lease, the properties or equipment is returned to the financier.
Long term leases on the other hand are a way of funding the purchase as opposed to the procurement of temporary services. They are commonly known as capital leases. Here, leased assets and financing liability are charged on the leaser’s books as though they were the ones acquiring the equipment.
The After-Tax Borrowing Cost
One of the main factors that will affect the ultimate financing decision is the issue of tax. All interest payments incurred from borrowing from bankers, bondholders and vendors are tax-deductible. However, shareholder dividends are not. The after tax borrowing cost is calculated as interest cost minus tax benefit. However, you should talk to your accountant before making any major financing decision.
Decisions about equipment financing will depend on various factors. The company accountant will be able to advise on some options to consider. However you will also want to talk to potential finance sources to get their input both in terms of their level of interest in the project and also what will the costs involved with their suggested approach.
Global Pacific Finance is a major player in equipment financing in NZ and they have plenty of experience to give you some ways forward.