Finance Column: Year-end purchasing advice

Now that we are nearing the end of another year, I thought it would be relevant to talk about year-end purchases and how they can best be handled on a company’s financial statements.

As the year commences, the market generally starts off slowly, sometimes due to a hangover from December, but from a standpoint of finalizing purchases, it is quiet.

Activity in March, April and May then picks up, inquiries that were made at the beginning of the year start to turn into purchase orders. At this point, shop owners have a good idea of what they need to get equipment in place so they can deliver product.

By the middle of June shop owners are starting to take vacation and/or are looking at shutdown dates for the summer, which in turn leads to a quiet July and August.

This year the summer was exceptionally quiet, which was most likely due to the falling cost of crude oil and the large economic implications that has for manufacturing in Canada.

The fall tends to be busy with a strong market and a show year, like 2015, which leads to a flurry of activity until the end of the year.

As a general rule, most companies tend to put off purchases until the fall, and that is usually because they want to see how the year goes before making a big commitment.

There is a lot of pressure to get it done because budgeted money needs to be spent or it will be lost going forward, or there are financial reasons to get a purchase “on the books” before the year end.

The ancillary benefit of having a strong market during a CMTS year is availability of inventory, machinery manufacturers and distributors will have had booths full of stock machines which are ready to be delivered before the end of the year.

Now if the equipment is in stock anywhere in North America, it can normally be delivered and invoiced in a matter of days or a few weeks, so getting the purchase into the current year is easy. There are however times where a machine may need to come from another part of the world, and getting it on a buyer’s floor by the end of the year could be challenging from a logistical standpoint.

From an accounting perspective, one question I get a lot from customers is related to how a purchase is actually accounted for from a financial perspective. When a piece of equipment is bought outright, either in cash, by using a bank loan or line of credit, the buyer will take immediate ownership, meaning the equipment will become an asset on their balance sheet.

A standard company balance sheet has three parts: assets, liabilities and ownership equity. The difference between the assets and the liabilities is known as equity, or the net worth of the company. From a taxation perspective the benefits of ownership will also allow the company to depreciate the asset, which is a fancy way of reducing earnings and in turn paying less taxes, hence the motivation to get the purchase on the books.

However if the purchase happens near the end of the financial year the tax savings could become minimized because the full year’s depreciation may not be allowed to be taken.

A preferred transaction method would be to set up an Operating Lease. Equipment leases are classified into two main categories: Capital Leases and Operating Leases. Capital Leases are treated in a fashion similar to the outright purchase of the equipment. An Operating Lease is a contract that allows for the use of an asset but does not convey rights of ownership of the asset—the leasing company maintains ownership.

The equipment is not put on the books as an asset but accounted for as a rental expense in what is known as “off balance sheet financing.”

Operating leases have tax incentives as well, but they do not result in assets or liabilities being recorded on the balance sheet. From a financial perspective, the company’s efficiency will improve dramatically since a new income generating piece of equipment has been installed allowing the company to return more sales and in turn profits from the same amount of assets.

An additional benefit of a capital or operating lease is how GST or HST are handled. Even though most businesses get all GST or HST back at some point, when equipment is purchased or if the funds are borrowed from a bank, the federal and provincial taxes are either paid in cash or must be borrowed (and interest paid). When equipment is leased it is the leasing company who pays the taxes in full up front and the lessee pays tax on each payment, so there is a positive impact on cash-flow.

What I have outlined here are some basic ideas for how transactions can be handled from a financial perspective, but it is imperative to reiterate the importance of having a discussion with your accountant or financial advisor before you proceed. They are experts who are best equipped to provide both a short and long term strategy for handling purchases from an accounting perspective.

I hope you’ve enjoyed reading as much as I have enjoyed sharing some of my personal experiences. Best wishes to you and your family for the holidays and a prosperous 2016.

Ken Hurwitz, Senior Account Manager with Blue Chip Leasing Corp. in Toronto, has years of experience in the machine tool industry and now helps manufacturers of all kinds with their capital needs. Contact Ken at (416) 614-5878 or ken@bluechipleasing.com.