Money Matters: Getting Back to Basics with Equipment Acquisition
by John Crum
July 1, 2010
Now
that there are signs of life in the U.S. economy, more contractors are coming
out of hibernation and starting to look for equipment to buy. Before you decide
to purchase, finance, lease or rent, you need to have a good idea of how the
equipment will be utilized. Different pieces of equipment often lend themselves
to different acquisition methods. Each contractor—by virtue of its size,
project expertise and financial resources—will have unique needs that make the
acquisition decision specific to that organization. There no such thing as “one
size fits all.”
Reasons to Buy
Whether paid for with cash or with a series of payments over a period of time,
the end result is the same: title to the equipment transfers to the buyer.
Here are some of the most important reasons to consider equipment
ownership:
• The piece of equipment you used for
doing your “bread-and-butter” work for years needs to be replaced with a newer,
more efficient machine.
• You need equipment for the long term
and want a reasonable expectation that it will hold its value well and can be
readily serviced.
• Although you understand the tax or
accounting benefits associated with other forms of use, you prefer to own.
Paying the full amount for a machine is an attractive option for some. A
certain satisfaction and security can come with knowing there are no future
payments. However, even if you can pay cash, you should consider whether you
want to tie up your cash in an illiquid asset.
Many contractors are not in a position to pay cash. Still others have
recognized the value in trying to match expenses with revenue generating
capacity and maximizing other tax and accounting benefits by financing, leasing
or renting their equipment.
Deciding Whether to Finance
For purposes in this column, “financing” means taking out a loan to pay for
construction equipment knowing that periodic payments will be made to the
lender for a period of time until the loan is paid off. In a financing
situation, the contractor owns the machinery, and the lender is granted a lien
on the machine until the contractor’s obligations to the lender are paid in
full.
Contractors often consider the financial benefits associated with financing,
including the possibility of conserving working capital. For example, paying
the full price of equipment in cash or making a sizable down payment will
result in a reduction of current assets. The greater the amount financed, the
more current assets can be preserved. If a trade-in is used instead of a cash
down payment, nothing is subtracted from current assets. In addition, only the
first year’s payments are added to the current liabilities
account.
Paying for equipment over a period of time may help contractors preserve their
lines of credit, which are often used for meeting short-term operating expenses,
such as payroll. This can help contractors preserve liquidity and increase
flexibility to use cash for other purposes. And rather than delaying your
equipment purchase until you have enough cash, financing may enable you to put
the equipment to work sooner and possibly have it pay for itself with increased
earnings by putting that equipment to work. In other words, financing provides
current use of the equipment while paying for it as you go.
Equipment financing may also provide other benefits, including the ability to
take depreciation deductions associated with ownership of the equipment. Ask
your accountant and tax adviser to determine how this may apply to any of your
particular transactions.
Financing with a term loan or with a line of credit may be a good choice if you
have a number of long-term contracts or a history of steady work. It makes
sense to finance if your pipeline of projects reasonably assures that you can
make payments for the term of the loan.
Financing can be arranged with the seller of the equipment or through a
third-party lending institution. Talk with your equipment dealer, who can often
refer you to a reputable lender. Make sure you work with a lender that has
experience in the construction industry.
Leasing Considerations
Leasing provides contractors with equipment for a specified period of time and
may also provide the user the option to extend the term of the lease and/or to
buy the equipment at the end of the lease term.
The primary financial benefit of leasing is that it conserves cash. The initial
payments under a lease arrangement are often lower than the down payment that
is often required in connection with loan financing. The terms of a lease may
be negotiated taking into account the useful life of the equipment, which may
lengthen the repayment term—and thus reduce the monthly payment amount. By
conserving cash that would otherwise be tied up in capital expenditures, a
contractor may be able to improve its bonding capacity, which may lead to
larger, more profitable projects.
Leases can be structured so that the amount paid during the entire term is less
than what would have been paid if the equipment had been purchased. This type
of structure reduces the risk of making a larger investment in equipment that
becomes obsolete or is no longer needed. By including a purchase option, you
can still have the opportunity to purchase the equipment at the end of the
lease term if it is not obsolete. Alternatively, lease terms can be negotiated
based on the full estimated productive life of the equipment. Consider your
project pipeline, the regional environment and government regulations to
determine how you foresee that equipment being used over the term of the agreement
and the type of lease structure that is likely to best address your needs.
A tax or operating lease may provide another benefit in that it does not appear
as debt on the balance sheet. However, the accounting rules regarding treatment
of leases are currently under review and may change. Depending on the type of
lease, the lease payments may be treated as capital or operating expenses.
Consult your accountant and tax adviser regarding the correct accounting and
tax treatment of the structure that you choose. The accounting treatment may be
particularly important when related to insurance bonding issues. The owner for
tax purposes is entitled to take the available tax benefits related to
equipment, including depreciation deductions. You should consult a tax adviser
to find out how those benefits may be available to you.
Leasing equipment does have distinct advantages if you don’t want to own the
equipment. If your company has special requirements on accounting for a capital
asset or managing tax burden, talk with a professional to determine your best
option.
Choosing to Rent
Renting is similar to leasing but usually involves a shorter term—12 months or
less. Some rental programs permit a percentage of each monthly payment to be
applied toward the purchase price, but for our purposes here, we’ll consider
renting as a way to use equipment for a short period of time with the intention
of returning the asset at the end of the term.
If you are uncertain whether you will need a piece of equipment beyond a
current project or if you have a project that is different from your usual
work, it may be better to rent rather than to finance or enter in to a
long-term lease. When there is a need to handle smaller, specialized projects
quickly, renting the specific equipment to meet the demands of each project may
be a good choice.
Renting is also a good solution for a project that requires technologically
advanced equipment you may not be familiar with or when you do not want to
commit to a purchase because of the uncertainty of the equipment’s resale
value.
By renting, a customer can use equipment without the associated debt that could
impact bonding capacity. In other words, payments are expensed to a project
without impacting the balance sheet. Lenders tend to prefer a healthy dose of
liquidity on a borrower’s balance sheet (cash, receivables, etc.), as opposed
to an undue proportion of capital assets, such as machinery. Over the long
term, renting through a series of short-term rental arrangements is likely to
be more expensive than loan financing or entering into a longer-term lease, but
it may be the best solution for contractors with limited capital resources or
short-term needs.
Finding the Best Option
The decision to buy for cash, finance your purchase, enter into a long-term
lease or a short-term rental arrangement must take into account your company’s
current position, its short- and long-term objectives and its anticipated
equipment needs. Each option has pros and cons. Take time to learn about which
solution is most appropriate for you.
John Crum
John.D.Crum@wellsfargo.com
John
Crum, national sales manager for the construction group at Wells Fargo
Equipment Finance Inc., has more than 20 years of experience in the
construction equipment finance industry.
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