The decision to purchase or replace a piece of large equipment may seem like a solitary operational decision.
In today’s market, however, the reality is nothing happens in a vacuum—changes in accounting rules, evolving tax laws, and other factors effectively require you to re-envision equipment purchases as part of a company’s larger capital expenditure strategy.
Here are a few essential components to consider before you make your next equipment financing decision.
The financial state of affairs
First, equipment purchases are about more than just your company's budget.
The Tax Cuts and Jobs Act has shifted the thresholds for when it makes sense to purchase, lease or finance. Businesses, for example, are now limited to deducting debt interest payments at 30% of earnings before interest, taxes, depreciation and amortization (EBITDA), yet can also expense more depreciation under the new reform.
Practically speaking, this means more heavily leveraged companies may be inclined to seek options beyond traditional debt financing.
Meanwhile, the upcoming accounting changes from the FASB requires lessees to recognize assets and liabilities for leases of more than 12 months.
“The new accounting rules and tax laws change the way people need to think about their capital budgeting and planning process,” says Ernest Tsorvas, President of Fifth Third Equipment Finance. “Changes in several accounting rules necessitate that companies adopt a 3-5-year time horizon for their strategic planning. These rule changes and this longer time horizon may lead to a different financing decision than in the past.”
Industry developments and cycles
Developments in the industry can have a significant effect on purchasing decisions as well.
Energy and marine, for example, are two cyclical industries currently experiencing extended down cycles—which could trigger tighter cash flows and dictate longer-term financing for companies in those industries looking to make purchases.
It’s important to work with a finance team that understands your industry so solutions can be tailored to your specific needs.
“Typically, we ask about the equipment itself—how it’s used, what its useful life is, plans for it after its useful life—to help guide us toward structuring a transaction that meets business goals,” says Tsorvas.
Innovation also plays a role in the decision-making process. If technology is on the horizon that might change the business model of the industry—potentially creating more opportunities for revenue and greater cash flow—it may also require equipment investment to leverage the advantage.
Understanding the dynamics within your changing industry can help your company’s equipment acquisition strategy—as well as lead to better, more advantageous financing options for this equipment from a strategic planning perspective.
Alternatives to debt financing
For some companies, the current landscape is less than ideal for financing equipment purchases with debt or buying equipment outright. Tight cash flow, a rapidly evolving industry or a capital intensive business model are all reasons to consider other options.
In some cases, leasing can function as an alternative. Businesses that are concerned about equipment obsolescence—tech companies, manufacturers, and contractors, for example—can use leasing to ensure they have the most up-to-date technology at their disposal. And because leasing doesn’t require a down payment, companies typically can conserve cash.
“People who historically haven’t had a need for leasing are thinking harder about how they really manage their capital structure going into the future,” says Tsorvas. “They’re starting to think traditional loan financing should probably be mixed with lease financing as well to fully take advantage of the tax benefits.”
The walk-away lease in particular is a great option for construction companies that may need a piece of equipment for a specific job. At the end of the term, the item can simply be returned to the lessor. Or perhaps the company will choose to continue the lease should they secure another contract requiring the same equipment. And aside from the flexibility, the lessor typically retains ownership and a full residual position—which means 100% of the equipment risk stays with the lessor.
Working through the options with your banking partner
It's always preferable to work through the complexity of equipment purchases with a seasoned professional who takes a holistic approach to such important decisions. Equipment finance experts should emphasize product delivery and customer service, with solutions designed to ensure you remain on the cutting edge, competitive, and able to meet the challenges of today’s leading industries.
“We look at the impact of various alternatives on the company’s financial strategy and tax situation as part of determining the best financing alternative for the business,” says Tsorvas.