INDUSTRY UPGRADE, Part 3: How to finance your equipment
This is INDUSTRY UPGRADE: a blog made for manufacturers. This series equips manufacturers with helpful tools for investing in new equipment, planning smarter, and facing challenges like labor shortages and rising material costs.
In Part 3: How to Finance Your Equipment, you will learn:
- The most common financing options for manufacturers.
- How to choose the right option for you.
- How to leverage the R&D tax credit when making your purchase.
Keep scrolling to read Part 3, or click here to get in touch with a financial expert with manufacturing expertise.
Choosing the right financing option is (almost) as important as choosing the right equipment.
Investing in equipment can help manufacturers open new sources of revenue, upgrade their speed and efficiency, take advantage of new technologies, and, in the wake of COVID-19, overcome challenges like labor shortages and rising material costs.
But it’s not just what you buy.
How you finance your equipment can impact your cashflow and shape the future of your business—for better or worse.
For manufacturers, a good rule of thumb is that it’s almost always better to have more cash on hand. Businesses in other industries may be able to skate by with lower reserves of cash, but in order to be successful in manufacturing you have to be able to make quick moves. You have to be agile, which often means making expensive investments on a short notice, while still retaining enough cash on hand to cover unexpected breakdowns, crisis situations, other new investments and routine operating expenses. A lot of things about the manufacturing industry have changed over the last few decades, but cash is still king.
Sometimes, choosing the right financing option is a matter of survival. Many otherwise-successful manufacturers have been brought down because they simply didn’t have the cash to keep their revenue stream running – this often happens during periods of growth or following a significant pivot – and they didn’t have an available line of credit to take on debt. Of course, financing equipment isn’t the only factor that affects your cashflow. But it’s a big one, and it can create ripple effects that impact other aspects of your business.
Unfortunately, choosing the right financing option can be deceptively complex; there are many different ways to pay for your equipment, and each one comes with its own costs and benefits. However, by having a basic understanding of your options – along with a few useful tips from Dugan & Lopatka’s financial professionals – you can see your decision more clearly and make your next move with confidence.
Let’s take a look.
What are the most common financing options for manufacturers?
Manufacturers rarely purchase equipment outright. Most equipment is simply too expensive. And even if they did have the cash on hand, spending it would reduce their cash reserves and make them vulnerable to cashflow problems.
Instead, manufacturers usually finance equipment with one of four options:
Option 1: Traditional Loans. When you take a loan from a bank to pay for equipment, there will likely be a down payment of 10-20 percent. As long as you have good credit, you should qualify for 100% financing for a 5 to 8-year loan (the optimal duration of your loan depends on your cashflow situation).
- There are tax benefits to taking a loan that you don’t get when you lease. You own the equipment, which means that you receive deductions for depreciation and interest.
- In most cases of manufacturing loans, there is no blanket lien of your company’s assets; only the machine itself acts as collateral.
- In some cases, your loan payments can be matched to your revenue – your shop makes payments based on the revenue it generates during a given period. This can help protect your business from cashflow shortages.
- When looking for a loan, you will have to choose between a fixed or variable interest rate. Variable rates start lower, but there’s always the chance that they will fluctuate. Fixed rates are pretty much always higher, but they come with the guarantee that the rate won’t change, giving you a clearer, more reliable picture of your upcoming cashflow and making it easier to plan future investments.
Option 2: Capital Leases. A Capital Lease entitles the renter to the permanent use of an asset. Capital Leases generally transfer ownership to the lessee at the end of the lease and are recorded on the balance sheet. One of the main advantages is that there are often preferred lease rates available from the equipment manufacturer. Another advantage is that, even as you make a large investment, you can keep your credit lines open for other equipment, expenses, etc.
- Another advantage of a Capital Lease is that you can pay your Sales and Use Taxes during the term of the lease, rather than upfront (as you would with an upfront outright purchase).
- As in a traditional loan, a capital lease often holds only the equipment itself as lien. A capital lease repayment plan can also be based off your revenue stream.
- Leasing may be the best option for companies with low credit or those that want to keep lines of credit open for other investments.
- One drawback: With a capital lease, you may miss out on some of the tax benefits that you could get if you took out a loan and purchased equipment.
Option 3: Flexible Payment Structures. In certain cashflow situations, your business may opt for a flexible payment structure, a loan repayment plan with periods of 30 to 180 days in which you can skip your payments. This allows you to maintain a positive cash flow while purchasing equipment that would otherwise be out of reach.
Option 4: Rental Programs. While less common than loans and capital leases, manufacturers sometimes choose to rent equipment. The advantage is that you get a short-term benefit without a long-term obligation; plus, it’s much easier for you to trade in your equipment for newer tech. The downside? Rental payments are extremely expensive compared to loan and lease payments, and you don’t get to deduct depreciation or take advantage of other tax benefits that come with ownership.
What is the right financing option for you?
The four options above are simply broad categories; within each one, there are a wide range of financing options, each with its own unique features.
Unfortunately, we can’t recommend the right option for you without knowing your business. It comes down to your cashflow needs, the cost of the equipment, your planned upcoming purchases, your risk tolerance, the market’s volatility, and other extraneous factors.
With that said, no matter what option you choose, the outcome is likely going to be better if you work with a financier who is experienced with manufacturing loans—someone who understands the industry’s best practices and terminology. Manufacturing works differently than other industries, and the same goes for manufacturing loans. You want a financier who knows how to navigate the terrain.
How the R&D tax credit can help pay for new equipment costs
You probably already know that the cost of nearly all equipment used in your business can be deducted from your taxes, most often as capital assets with the depreciation deducted over the ‘useful life’ (a period of time defined by the IRS) of each asset.
However, what often gets lost in the equipment-financing conversation is the R&D Tax Credit. This is an opportunity for huge tax savings, and the majority of mid-sized businesses miss it.
Although a “research and development” credit may sound like it’s for a research lab or a tech startup, a whopping 70% of R&D credits are claimed by manufacturers (usually the largest players).
And you don’t have to revolutionize the industry to claim the credit. In fact, many of the expenses involved in purchasing new equipment – such as installation, reconfiguring the shop floor, proof of concept steps, and any workflow improvements – may qualify.
Purchasing new equipment always puts a strain on your cash flow. But, by planning ahead, understanding your financing options, and pursuing savings opportunities like the R&D tax credit, you can upgrade your operation while protecting your bottom line.
Keep learning. Keep upgrading.
Thanks for reading Part 3 of INDUSTRY UPGRADE!
In Part 1, which you can read here, we covered how manufacturers can assess their needs, better-understand their finances and begin planning new investments.
In Part 2, we walked through the best practices of creating a cost-benefit analysis.
Financial guidance, made for manufacturers.
At Dugan + Lopatka, our team of financial experts has served manufacturers in the Chicagoland area for more than four decades. We provide a comprehensive range of financial guidance and accounting services to help you overcome emerging challenges, maximize your profitability, plan successful investments, and strategize for the future. Contact our team to learn more.