Understand year-end purchasing

In a busy market like the one we have had in 2018, there is normally a flurry of activity as the year comes to a close. Manufacturers are quickly working to get funding approvals in place so they can have equipment on the floor before the end of the year.

Over the years, first as a machine tool seller and now in the finance industry for almost nine years, I see it as a common year-end occurrence. This time of year, it becomes very relevant to talk about year-end purchases and how they are logged in financial statements.

For the most part, 2018 followed suit like any other. Machine shops tended to put off purchases until the fall because the investment is significant, and they wanted to see how the year went before buying equipment. It clearly didn’t help that a running theme for the year was the NAFTA renegotiation, which contributed to a substantial amount of angst along with market uncertainty.

Now as the year draws to a close these same shops are under pressure to get purchases done because either budgeted money needs to be spent or there are financial reasons to get a piece of equipment on the books before the year ends.

Look for year-end deals

It is also a good time to get a great deal on an in-stock or demo machine. Sellers are acutely aware of the buying cycle, and therefore know that now is the time to move inventory because January and February are traditionally slower months.

If the machine is in stock in North America, it can be delivered and invoiced in a matter of days or weeks, so getting the purchase into the current financial year is easy. Sometimes, however, a machine has to come from another part of the world and getting it on the floor by the end of the year is challenging from a logistical standpoint.

When a piece of equipment is bought outright, either in cash, via a bank loan, or with a line of credit, the buyer takes immediate ownership, meaning the equipment immediately becomes an asset on the balance sheet.

Ask your accountant

A standard balance sheet has three parts: assets, liabilities, and ownership equity. The difference between assets and liabilities is known as equity and is the net worth of the company.

From a taxation perspective, the benefit of ownership is that it allows the company to depreciate the asset, which is a fancy way of reducing earnings and, in turn, paying less taxes. This usually drives the motivation to get a purchase on the books by the end of the year. However, if the purchase happens near the end of the financial year, the tax savings are minimal because the Canada Revenue Agency may not allow the full year’s depreciation to be taken.

It is very important for any business owner who is contemplating a year-end acquisition to have a conversation with their accountant before any purchase order is issued.

A preferred method to handle year-end transactions for many shops is to set up an operating lease.

Accountants classify equipment leases into two main categories: capital leases and operating leases. Capital leases are treated similarly to cash purchases or bank loans. An operating lease is a contract that allows for the use of an asset but does not convey any ownership rights of the asset. The funding institution maintains ownership. The equipment is not an asset of the company, but instead accounted for as a rental expense.

Operating leases have very appealing tax incentives because the payment is expensed like any other ongoing cost, such as tooling, material, and labour.

Another ancillary benefit of the operating lease is that no additional assets or liabilities are recorded on the balance sheet. This means, from a financial perspective, the company’s efficiency will improve dramatically since a new income-generating piece of equipment has been installed, which allows the company to make more sales and, in turn, profits from the same amount of assets.

Last, manufacturers that borrow significantly from the bank, whether it is in the form of a straight loan or an operating line, will have financial covenants that must be maintained. These ratios, including the debt-to-equity ratio and restrictions on debt levels, all must be maintained.

If equipment is added in the form of a capital lease, meaning both the asset and liability are noted on the balance sheet, it can throw off these ratios and could result in the shop no longer being in compliance with its banking agreement.

These are some basic ideas for how transactions can be handled from a financial perspective at the end of the year, but, once again, it’s important to speak with your accountant before proceeding with any purchase. They are the experts who are best equipped to provide both short- and long-term strategies for handling investments from an accounting perspective.