Use your money wisely: Part 1

Correctly managing leases, loans, cash flow keeps businesses financially healthy

Q: Why would I want to lease a machine?
A: The textbook answer is that you should pay cash for assets that appreciate and lease/finance assets that depreciate. However, real life rarely works like textbook answers.

Q: How should a lease payment compare to generated revenue?
A: When leasing you have the ability to match monthly lease expenses directly to revenue. Instead of dealing with a large initial cash outlay for a more expensive machinery purchase, the lease payment typically is (or ought to be) a small percentage of the monthly revenue generated by the equipment.

For example, the lease payment on a $100,000 vertical machining centre works out to approximately $1,900 per month over five years. But this piece of equipment should generate a minimum of $12,000 to $14,000 per month in revenue.

Q: What effect will a lease have on my cash flow?
A: Working capital is king, and nearly all businesses struggle with cash flow.

Problems can arise collecting receivables, additional material may be needed for a large order, tooling may be needed, or you may need to hire another operator. All of these require cash flow. With a lease, there’s no need to tie up valuable cash in an expenditure that can be financed. Cash is better used in areas that can’t be financed, such as hiring of additional staff, product development, or as a deposit to buy your current unit or manufacturing facility.

People assume financing is for the guy who can’t write a cheque, but my biggest clients are successful manufacturers who can write a cheque but choose to spend their money elsewhere.

Q: How would a lease affect my ability to secure a loan?
A: The typical leasing company isn’t looking to be your bank. In a perfect world, leasing companies complement the financing you already have in place. Most astute manufacturers use their bank for an operating line to cover short-term needs and use lease financing for long-term debt.

As a business owner, you should never use short-term financing like an operating line to pay for a long-term asset such as manufacturing equipment.

Q: How long does it take to get a lease?
A: Most of the inquiries I get are from manufacturers that have either just secured a contract and won some new business or got more work from an existing customer. In both cases, time is of the essence, and getting machinery or capital in place quickly is paramount.

A well-organized leasing company has the ability to react within hours and at worst in a matter of a few days. This type of response isn’t what most people experience with their bank or preferred lending institution.

However, simplicity and convenience extend far beyond quick responses. Once a deal is signed and assuming the account remains in good standing (payments are made on time each month), you should never hear from your lessor except during the holiday season when it sends out gift baskets.

Doing business with a bank will mean monthly reporting from either your accounting department or bookkeeper as well as yearly reviews. These additional costs, which can be significant, are not reflected in the rate the banks charge.

Q: Will my rate ever change?
A: No. Once you sign a lease, the monthly payment and interest rate is fixed. A bank or lending institution will rarely if ever fix a rate, so over a five-year period, you are subject to interest rate fluctuations. We’re currently in a rising interest rate environment, so locking in a payment (interest rate) for a five-year lease makes a lot of sense at this time.

Q: Are there tax incentives to leasing?
A: Yes, definitely. Although I’m not an accountant, I can tell you 99 per cent of my clients write off 100 per cent of their lease payment as an expense the same as they do for tooling, material, and wages. From a taxation standpoint, a lease can make a lot of sense with the significant savings in tax dollars alone. That said, I always tell my clients to have a conversation with their accountant or bookkeeper before they proceed if this factors into their decision-making process.

Q: Can I lease a machine for a short time such as six months?
A: This is a tough one for any funder. Short-term money is very hard to find in today’s market because it is difficult for any lender to make any type of profit.

A typical leasing company will get its money from a number of different sources, but the most common funder is institutional money, which is a fancy way of saying large life insurance companies.

The bulk of their holdings are invested in Canada Bonds for the obvious reasons of security as well as the need for long-term money. This means they will not want to put money out for less than two years, with a typical lease running anywhere between two and five years.

If a short term is required, and the seller of the equipment is unable to accommodate (in many cases, it will provide these types of terms), then the only way to access capital would be to utilize some sort of equipment or operating line of credit.

This typically is not the best use of these lines, and for a high-price piece of equipment, six payments would cause major problems with a company’s cash flow.

Ken Hurwitz is senior account manager, Blue Chip Leasing Corp., 416-614-5878, www.bluechipleasing.com.

About the Author
Equilease

Ken Hurwitz

Vice-President

41 Scarsdale Road Unit 5

Toronto, M3B2R2 Canada

416-499-2449

Ken Hurwitz is the Vice-President of Equilease Corp.