Improve your processes with leased software

The most successful clients I have are the ones investing in new technology.

Some have recognized the need to upgrade to a multiaxis CNC lathe because their work needs to be both turned and milled. By adding one machine that can complete the part in one setup they dramatically increase both capacity and efficiency and, in turn, their bottom line.

Other clients have purchased a 5-axis machining centre because the setup time for machining a part on a 3-axis machine was killing their profitability and preventing them from quoting competitively.

Investing in new machine tool technology is just the first step, granted the largest one, but still the first step in improving both efficiency and profitability. Having the newest technology on your floor is great, but if systems aren’t in place to support it, then the gain could be compromised.

Don’t forget about software

The best example I have come across recently occurred when a client installed a new machine but continued to use 10-year-old software.

I asked a software seller with whom I do a lot of business about this specific issue and he put it best when he said, “There are three main areas that impact a manufacturer’s efficiency: the machine, the tooling, and the software, and your ability to be productive will only be as strong as the weakest link.”

We then talked about a few mutual customers of ours who had recently upgraded by leasing some new CAD software.

One machine shop was a Tier 3 supplier to the aerospace industry that just bought a new 5-axis machining centre but had not upgraded its software system in years. The new machine improved cycle time, but not as dramatically as was anticipated.

It wasn’t until new software was used, at a cost of roughly $12,000, that the benefits of the new equipment were fully realized. In this case, the cycle time for the part, which had been 2.5 hours, was reduced to 25 minutes.

A second shop works in the telecom industry and had also recently installed a 5-axis machine. It produced a few different part generations that were taking eight hours to program and had a cycle time of 12 hours.

An investment in new CAD software was approximately $30,000, and the result was a reduction in programming time to only three hours and a cycle time of five hours.

The savings for this shop were so dramatic that the ROI for the machine, which was originally pegged at 24 months, became less than one year.

Other leasing possibilities

What I find interesting is the number of manufacturers that are very familiar with machine leasing, but don’t realize that arranging financing for software can be done just as easily.

Now, securing financing for software isn’t handled exactly like lending for a hard asset with a good resale value, like a machine, for the obvious reason that in the event of a default, there is nothing to repossess and, in turn, resell. There is really no exit strategy for the lending institution.

This is considered covenant lending, meaning the company and its shareholders are all that is reviewed, and the approval is based solely on whether they can financially support the entire amount of the transaction.

However, because the typical transaction value is under $50,000, and in many cases significantly less, if the business is well-established and has some history of borrowing, then the application process is simple. It can be processed within one business day, with the approval not usually requiring a shareholder guarantee.

The reality is that a lender with experience in the manufacturing industry understands the cost of the software is insignificant when measured against the increases in productivity and efficiency that will materialize once the software has been implemented.

Tax implications

It’s also important to note that the software industry is changing, resulting in additional benefits from a taxation perspective.

Normally software, whether it is purchased outright or financed, is owned by the user in perpetuity, requiring only yearly maintenance costs for upgrades. This means a large upfront cost with significantly smaller fees for maintenance.

However, the market is changing, and some of the largest software developers are moving toward a subscription model.

This means that even though pricing has come down, in some cases by up to 75 per cent, once the subscription expires, a new one must be purchased or leased.

From an accounting perspective, a preferred method to handle this type of transaction is to set up an operating lease, which is a contract that allows for the use of an asset but does not convey rights of ownership. The leasing company maintains ownership.

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

Operating leases have tax incentives because the payments made over the year are expensed and do not result in assets or liabilities being recorded on the balance sheet. The yearly cost essentially reduces the business’s operating income so the tax savings come from a reduction of that income.

If the decision to add software is predicated on how it will be handled from an accounting standpoint, it is very important to have a discussion with an accountant or financial adviser before any transaction is finalized.

For Canadian manufacturers to remain competitive on the world stage, investing in new technology is very important, but it is just as important to ensure the new technology is used in the most efficient manner possible. Sometimes it’s a relatively small additional investment that makes all the difference.