Auto Suppliers Use Strategic Financing for New Equipment

Equipment financing should be as smart as today’s cars. Discover options to keep your business competitive.

The auto industry is seeing the greatest changes to its business since mass production enabled Henry Ford to turn out a Model T every 24 seconds a century ago. Indeed, several current trends—from digital technology and alternative fuels to lightweighting—promise to change how automobiles are designed, what they do for users and how they are manufactured.

Original equipment manufacturers (OEMs) rely on tier-one and tier-two suppliers more than ever to gear up their lines to produce the parts and assemblies needed for the latest advances, all within tight time frames that require suppliers to invest heavily in new production equipment. It’s a capital-intensive undertaking, especially when lead times are long and suppliers won’t potentially see revenue from their contracts with OEMs for two years or more. Certain kinds of financing can bridge the gap, however, and pave the way for suppliers to retool as needed while they use their cash for other priorities.

Auto Trends Affect OEMs and Suppliers Alike

Of the many trends influencing the auto industry today, three stand out. First, there’s digital technology, including artificial intelligence (AI), which enables cars that are smart, self-driving and connected to the internet. Recent Accenture research says AI has the greatest impact on smart products, with 54% of automotive companies and 37% of industrial equipment (IE) companies expecting AI to significantly change auto products and manufacturing. OEMs expect to invest heavily in related areas, including deep learning and video analytics, while IE companies expect to invest in robotic process automation and computer vision.

Also topping the trends list are alternative fuels. Industry Week notes that the alternative fuel market will reach $614 billion by 2022. Electric vehicles (EVs) are a big part of that trend. Smart suppliers are responding now, according to PriceWaterhouseCoopers, because first movers have the advantage. EVs and hybrids require new manufacturing processes, including robotics, which suppliers and OEMs are using to streamline, automate and diversify production at greater speed.

The third trend affecting OEMs and suppliers is the quest for lighter-weight chassis and greater fuel efficiency. Both are reconsidering the materials and construction and production techniques they use. Some companies are working with aluminum, magnesium, plastic, carbon fiber and hybrid materials, using new equipment for injection molding, bonding, hydroforming or laser welding.

Financing for Suppliers’ Unique Equipment Needs

Purchasing new equipment with cash to accommodate these trends may not be possible or desirable, even if suppliers have it at the ready. Instead, many suppliers use lease financing as an alternative. Leasing limits asset risk, enhances cash management, and offers greater financing flexibility.

Lease financing minimizes up-front costs and supports better cash flow because it is a 100% advance. Using this type of financing, rather than cash, helps suppliers guard against the cyclical nature of auto production and its impact on their large investment in upgrading equipment. For instance, it gives suppliers flexibility when rapid technological advances end a cycle run and businesses have to swap out full lines that produced now-outdated technology and replace that technology with cutting-edge equipment. Leasing offers a solution to help suppliers ramp up production and lessen the impact should technology shift or the industry plateau or see a downturn. There are risks associated with the potentially lengthy gap between cost allocation and revenue recognition, but leasing offers an effective approach, especially when suppliers have contracts with OEMs that define in advance the number of parts and revenue the equipment will generate.

Another feature of leasing is the option for progress payment funding. With this option, the lessor takes the purchase order assignment and owns the asset. It manages the invoicing and pays vendors on behalf of the supplier, which makes interest-only payments until the equipment is delivered and the lease is finalized. Suppliers benefit from this strategy because it gets production of the needed equipment going quickly with no upfront cash. What’s more, when companies use leasing and a tax-lease structure, they never take ownership of the equipment. This eliminates the potential for a sale-leaseback (and the possibility that they may have to pay twice the amount of sales tax they would otherwise have to pay).

Leasing Frees Cash for Other Uses

Leasing can be part of a company’s bigger financial picture. If its owners are private equity or a family, the financing lets it use capital to expand through acquisition or organic growth. Free cash flow also enables a company to pay dividends, make stock buybacks or pay investors in other ways.

What’s key is working with an experienced equipment finance provider who will walk the company through strategic options and a cost-benefit analysis. It is a top-down approach that begins with the ownership structure, then looks at capital allocation before recommending financing options. It is important to start this discussion early, as contracts are awarded up to two years in advance of production and funding can be key for planning purposes. Given every factor, financing equipment is ultimately about much more than the purchase—it can be a key component of an auto supplier’s long-term financial strategy.