If anything, 2020 really showed businesses and companies how to stay resilient during a global pandemic. COVID-19 has forced thousands of companies to evolve, to look at their current practices, or working capital to make ends meet at the end of every month.
One of the key areas that companies have had to really focus on has been their equipment acquisition and fleet management. This area, for most companies, has had to take a back seat during the uncertain times for funds to be pushed into the day-to-day running of the business.
The problem with no equipment being purchased or acquired for the company is that the company stagnates and stops expanding. Equipment is key for the daily functioning of the company, but it is also vital to remain competitive in a highly cut-throat environment. New equipment means new service offerings.
Whether you are replacing old, outdated equipment, like office technology, for example, or you are looking to add a truck to your fleet, this addition will mean that you can reach more customers, or be able to service customers quicker and easier with the latest technology.
No matter what industry you are in though, new equipment comes with a hefty price tag. So, we thought we would unpack the various options of equipment financing, and how to choose a business equipment loan that will suit your company. Let’s get stuck straight in.
Map Your Strategic Trajectory
The first thing you will need to do before simply going ahead and making a large purchase is doing a deep dive into your company. You will not only need to understand what the current financial standing is of the company, but also know what the strategic trajectory is for the next few months to years.
What are the long-term and short-term goals of the company? Are you looking more at internal development, or are you on a rapid expansion trajectory? What are your competitors currently doing, and what is your competitive advantage?
Purchasing new equipment can lead to a wider service offering, or you might be able to service a wider range of customers. Let’s take a look at an example. If you are in the manufacturing industry, a large piece of equipment could mean that you can extend your product line, or even streamline some of your processes. If you are in the transport industry, a new truck or semi-truck could mean that you reach more customers in less time.
But, you could also be in an office, and simply looking to upgrade your technology like your laptops or printers. This could mean more efficient admin or more functioning in servicing your clients.
Have A Firm Insight Into Your Finances
With this expansion, and additional equipment comes a price tag. In many cases, like manufacturing and aviation, this can be quite significant. So, you will need to work out what your financial standing is before simply making a purchase. Calculating what your working capital is is integral to the business equipment loan process.
Your working capital should be sufficient enough to cater to your day-to-day operations like rent, wages, and operational expenses. It will also need to cover you in case of unexpected economic downturns. So, integrate at least three months’ worth of emergency savings into your working capital calculations.
Take COVID-19, and the sweeping effects it had on business globally. Lockdowns forced millions of businesses into an idle state, and many struggled to maintain the day-to-day expenses of running the business.
The purchasing of a new piece of equipment can take a massive chunk out of your necessary working capital. So, it may be worth your while to look at breaking up the purchasing price of equipment into manageable portions. A business equipment loan or lease divides up the full purchasing price into monthly installments which make up part of your monthly expenses.
The monthly installments will be spread over a period of time, whether it be two to six years, depending on the cost and usable lifespan of the equipment. A truck, or vehicle, for example, will usually have a lifespan of around five to six years and will be financed or leased for that period of time.
Weigh Up Your Financing Options
The next thing to look into is what kind of financing you have to choose from. Here, we are going to delve particularly into equipment leasing and business equipment loans.
A loan is a financing option whereby a company borrows money from a bank or finance house to purchase a piece of equipment. A lease, on the other hand, is a term rental agreement for the use of a piece of equipment.
Based on your specific needs and financial standing, you should weigh up your options when it comes to a lease or a loan as both come with different pros and cons. A business equipment loan, for example, will have fluctuating rates, so the overall monthly cost of the equipment might fluctuate slightly, due to the change in interest rates. A lease, on the other hand, will remain at a constant monthly installment until the end of the term.
A loan will also only finance around 60- 80% of the equipment, excluding added costs, while a lease will cover full usage of the equipment and include add usage costs. Let’s take an office printer, for example. If you are leasing a printer, the lessor will be responsible for the maintenance, servicing, transport, insurance associated fees that come with the printer. They will also be responsible to train the staff to use the equipment and for any troubleshooting needs.
In the case of a lease, especially an operational lease, the lessor will have ownership of the equipment throughout the duration of the lease. A loan, on the other hand, means that the business taking the loan for the equipment will own the equipment. This is why they will be financially responsible for all aspects of the equipment.
Loans are also less negotiable than leases. In the case of a lease, because the lessor still owns the equipment throughout the duration of the lease, the equipment is considered collateral. In case of payment defaults, a lessor can simply retrieve the equipment, so it is a less risky option.
Loans, on the other hand, are riskier to financial institutions. It is for this reason that financial institutions will conduct credit checks on companies prior to providing them with a loan. So, if you are a brand new company, or have a bad credit history, you are less likely to be granted a loan than a lease.
Know The Impact It Will Have On Your Finances
Accounting plays a large role in determining which option would be better for your company. It is important to remember that investors and future creditors will want to examine your balance sheets and statements in order to determine your levels of risk and risk appetite.
If you currently have extensive credit, it will be less likely for a credit provider to offer further credit unless you can guarantee regular payments. It will also be important for you to know how tax-deductible the loan or lease is. In many cases, especially in leasing, you are able to write off a large portion of the amount to tax.
Let’s take a look at the reporting of each separately.
Loan Accounting
The first thing that you will need to take into consideration is the term of the business equipment loan. If it is a loan taking place over just a year, it will be considered a current liability. But if it is a loan over a number of years, it will be considered a long-term liability. It is also key to know that you will also have to divide the amounts up. The amount due for the current year will be recorded as a current liability, while the balance will be recorded as long-term.
The amount received from the bank, which will then be used to purchase the equipment and is referred to as the principal amount, will be recorded with a debit to Cash and a credit to a liability account, such as Notes Payable or Loans Payable.
Because the principal amount is not part of the company’s revenues, it will not be reported on the income statement. You will need to enter a debit to the cash account to record the receipt of cash from the loan and enter a credit to a loan liability account for the outstanding loan.
The interest will be recorded separately as it is charged periodically and due to the fact that the interest rate might fluctuate. Interest is debited to your expense account and a credit is made a liability account under interest payable for the pending payment liability.
Lease Accounting
Before simply delving into leases, you will need to know the difference between an operating and capital lease. A capital lease will usually result in the lessor taking ownership of the equipment at the end of the term and after a residual amount is paid off. This could even be $1 (hence why it is referred to as a $1 buy-out lease), as long as money is exchanged.
In an operating lease, the lessor will never own the equipment, and is merely paying to utilize the equipment. This will mean that the lease is recorded similarly to monthly rent. It will be recorded as an operating expense to the company, and both the amount can be tax-deducible, and the interest written off to tax.
In the case of a capital lease, it will be recorded differently.
- It will be recorded as an asset and a debit to the appropriate fixed asset account, and a credit to the capital lease liability account;
- Interest should be recorded regularly, on receipt of invoices. A portion of the payment should be recorded as interest expense, and the balance in the capital lease liability account;
- Lastly, you will need to record the depreciation of the asset too. Because you will be owning the equipment like a normal asset, you will need to record the depreciation as well as plan for the disposal of the equipment.
Find The Right Company
The last thing to consider it who you will be gaining the financing from. As mentioned, loans are tougher to acquire than leases. Because of the higher risk, banks and financial institutions will need to examine your credit history, be provided with a business plan as well as financial statements. The process of getting a loan is more in-depth and complicated than acquiring a lease, simply due to the risk attributes.
But, whether you are getting a lease, or a loan, it is important to research the financing company first. Especially in the case of a lease, you will need to know that you can negotiate some of the terms that come with a lease. From interest rates, to the duration of the lease, to the added costs of the lease. The lease will ultimately be benefiting the lessor, so negotiate as much as possible.
In the case of a loan, many of the terms may be more set, but there are aspects that you will be able to negotiate. Shop around for a company who will be open to negotiations.
The last thing to look for in a financing company is to look for a company who will partner with you. The right company will evaluate your business, take your unique needs and company profile into consideration and structure a finance package for your unique needs. They will also have in-depth insight into the industry and market conditions, so they will be able to guide you against the risks and help you avoid pitfalls in the financing process.
Wrapping Up
Before entering into any financing agreement, it is important to do thorough research and due diligence prior to signing. You will also need to take each aspect of your company in consideration. Bring your financial advisors as well as tax consultants into the process as they will be able to guide you correctly and ensure that you get the most out of the agreement.
