Whether you’re operating in the agricultural, industrial or service sectors, you know that your business depends on quality equipment. Running a successful business depends on investing in new machinery and upgrades. Upgrading your equipment increases your company’s productivity, widens your profit margins and raises total revenue. However, if you’re an owner of a small or medium-sized enterprise, buying new equipment can be a significant financial burden. The up-front hit to your company’s budget when you purchase new machinery can affect your business in a big way, at least temporarily. At the same time, it could take years to reap the financial benefits of the new equipment.
Does this mean that you have to sacrifice an investment opportunity for the financial solvency of your business? Of course not. Financing equipment is a reasonable solution to help you make a sound business investment without postponing it indefinitely. When you resort to financing equipment, you can fulfill your business needs sooner. The new equipment will help your business be more productive, and you’ll eventually make more money.
There are many options that will allow you to finance your equipment: equipment loans, term loans, Small Business Administration loans, lines of credit and credit cards.
Equipment financing allows you to purchase the equipment by making periodic payments until the value of the equipment is paid off. The equipment itself serves as collateral. If you fail to make the payments, the lender simply repossesses the equipment. Lenders may also require additional collateral in the form of a blanket business lien for the entirety of your company’s equipment or a personal guarantee. Since the required credit score for an equipment loan is lower than other financing options, annual interest rates can range from 8 to 30 percent.
Term loans are the most traditional type of loan. They have annual percentage rates and require a credit check. Business owners can choose between secured and unsecured loans. Secured loans are similar to equipment loans in that you have to provide some sort of collateral to guarantee the loan. Since term loans aren’t always secured, though, they require a higher credit score on the part of the business owner than equipment loans do. Both equipment loans and term loans from private lenders have fast cash turnover times and application approval because business owners can input the relevant information online. If you have very good credit, term loans can be a financially sound option because a higher credit score can reduce your APR and save you thousands of dollars.
The U.S. government offers loans to small business owners through the SBA. Consider the SBA’s Certified Development Company CDC/504 program for your equipment financing needs. This SBA program is specifically for for-profit businesses that have earned less than $5 million after taxes in the past two years and have a fungible net worth under $15 million. SBA loans have some of the most flexible loan conditions. Loan amounts reach up to $5.5 million, and the repayment terms extend up to 20 years into the future. CDC/504 loans are secured loans with both the equipment and a personal guarantee as collateral for the loan. CDC/504 loans have some of the lowest annual interest rates, hovering at approximately 4.25 percent.
Lines of Credit
Lines of credit are another equipment financing option for business owners. A line of credit is a fixed amount that you can draw from repeatedly to meet the routine or emergency needs of your small business. While high credit scores correlate to higher lines of credit, low credit scores increase the amount of interest that you’ll have pay. Lines of credit are short-term credit instruments, so soaring interest rates could reach as high as 36 percent. If you believe that financing equipment will lead to inflated, short-term productivity gains, then a line of credit may be a viable option for you. Otherwise, it’s best to consider other loan options.
Business credit cards are a great way to earn cash-back rewards for your equipment purchases. However, since the credit limits are so low, approximately $50,000 to $100,000, credit cards only make sense for small business owners whose equipment costs are relatively small but still loom large as compared to the business’s actual revenue. Credit cards have high interest rates in addition to their annual fees. Financing through credit cards isn’t a proposition that pays off in the long term. For long-term financing, business loans are more appropriate.
Financing equipment is a major decision. In the end, it all comes down to timing: Are you ready to take the next step and grow your business through financing new equipment? Can you afford it? Are you afraid of financing your equipment and defaulting on your business loans? What if the gains in productivity don’t compensate you for the money you spent on the new equipment and aren’t enough to make your fixed loan payments? What if, after all the information you have, you’re still not sure if it’s really the right to time to finance equipment? Here are some examples of when financing equipment is the right business decision.
Old Equipment Is Creating Dangerous Conditions
As a business owner, the greatest responsibility you have is to ensure that your employees and workers are working in safe conditions. Dangerous working conditions can cause death or injury to workers, forcing you to pay out millions of dollars in work-related injury civil suits and raising your insurance premiums. Old and unsafe equipment can also damage the final product given to your customers. Lawsuits and bad publicity from your customers could lower your Better Business Bureau rating and see your business shut down for good.
In this scenario, even if you don’t expect to see significant productivity gains from financing equipment, you will reduce the financial exposure and risk to your company. The potential savings when compared to civil suits or criminal negligence charges are incomparable.
Old Equipment Significantly Reduces Productivity
Technology is constantly evolving. Don’t let your business get left behind because you’re afraid to invest in new equipment. It’s time to finance your equipment when your old machinery starts to cost you an exorbitant amount of money and time. In some cases, machinery is replaced by newer models or different equipment altogether. If you don’t update your equipment to keep up with industry trends, you won’t be able to keep up with demand or your productivity and output goals.
Waiting too long to replace your equipment can result in the nightmarish specter of being stuck with obsolete and useless equipment that has neither production value nor sale value. Not only will you be unable to fulfill your production goals and meet consumer demand, but you will also find yourself in a desperate position. When you take out business loans to finance equipment before you absolutely need it, you have some control over the financial outcome for your business, and you have a measure of choice regarding the loans you consider and their repayment conditions. If you become desperate to finance new equipment, your bargaining position becomes extremely weak, and you lose control over your business’s financial future.
The first thought that goes into a business owner’s head when a key piece of machinery breaks down is that they can just repair it. Repairs and maintenance can be extremely costly and time-consuming, however. Older equipment models require more upkeep than their newer counterparts. When the machines aren’t working, it results in less productivity and income, meaning that the total cost of the older equipment isn’t just the money spent on its repair but also the value of the lost earnings and income.
Smart business owners should run a quarterly cost-benefit analysis on every piece of old equipment. This way, you’ll be able to figure out the actual cost of continuing to use outdated equipment. Your cost-benefit analysis should factor in production levels, the age of the machinery, whether you bought it old or used, the frequency of repairs, the cost of maintenance, the cost of replacement and the expected productivity levels of a newer model.
Don’t bother to finance equipment if your calculations reveal that new machinery will only marginally increase your company’s efficiency and revenue. In this case, the time and cost of the installation won’t reach the profitability threshold to make it a worthwhile investment. However, if your projections reveal that new machinery will dramatically increase your productivity, you will not have to wait long to see the fruits of your investment.
Financing equipment is a practical method to replace old machinery, especially when it will take a few fiscal years for the financial gains from the new machinery to cover the cost of its installation. Taking out a business loan can ensure that your income remains in the green while guaranteeing continued output and productivity.
Leasing Is No Longer Financially Efficient
New business owners may have no alternative to leasing their equipment because they have neither the capital to purchase new equipment nor the positive credit history and business sustainability to feel confident securing business loans and financing equipment. However, once the business has been running for a few years, the financial efficiency of leasing equipment begins to decrease. Lease payments for equipment are not an investment; there is no ultimate gain for you as a business owner. Although you may believe that you are saving money because you’re under no obligation to repair equipment that you don’t own, failing to own your machinery means that you’re missing out on a prime investment opportunity to grow your business.
Even if you buy equipment that your business no longer needs in the future, selling old equipment can pave the way to obtaining new equipment by deferring the total cost. Financing equipment and leasing equipment both have the same effect on monthly revenue because you still have to make fixed payments. The critical difference between financing and leasing is that at the end of the financing period, you will own the equipment that you’ve been paying for.
Deciding between financing and leasing requires another cost-benefit analysis. You will have to differentiate between your short-term and long-term business objectives. It can be said that leasing requires neither a down payment nor collateral. Knowing your goals will then allow you to specify your operational needs and decide whether the investment of financing equipment is the right solution for you.
In conclusion, equipment financing can be a positive step forward in the growth and development of a business. As long as you feel confident that your increased revenue will suffice to meet your monthly loan payment obligations, you can obtain a loan and move forward with your new equipment. You’ll want to choose the equipment financing option that best suits your business and matches your short-term and long-term goals.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.