Cash is king when running a manufacturing business

We now are well into 2021 and the market seems to be in recovery mode. It’s a good time to get new equipment on the shop floor and take advantage of the buying opportunities that are presenting themselves in the marketplace.

Following the economic downturn caused by COVID-19, there is no doubt that it can be incredibly difficult for some shops to purchase the latest in machine tool technology with cash because of the high cost involved. This means that finding an alternative source of funding is necessary, and some manufacturers may want to consider lease financing.

But why lease? The textbook answer is that you should pay cash for assets that appreciate, and lease or finance assets that depreciate. But, as we all know, real life rarely follows textbook answers, so here are a few real-world replies to the question.

1. Comfortable monthly payments

When leasing, you take the selling price of the machine out of the equation and evaluate the transaction based upon monthly lease expenses against revenue, instead of dealing with a big cash outlay for a machinery purchase.

The lease payment usually is (or should be) a small percentage of the monthly revenue generated by the equipment. For example, a $200,000 machine tool can be leased for approximately $3,950 per month over five years but could generate $15,000 per month in revenue.

2. Working capital is king

All businesses struggle with cash flow. This happens because customers rarely, if ever, pay on time. If a large purchase order arrives and there is a need to purchase additional material or tooling or hire another operator, you need cash. This is why a business needs to have money in the bank and should not tie up valuable cash in expenditures that can be financed.

Cash is better spent in places where it provides the greatest return, such as costs related to new product development, improving your engineering/applications department, hiring an additional salesperson, and even as a deposit to purchase your own building.

People assume that equipment leasing is for business owners who can’t write a cheque—and in many cases, it is. However, my largest clients are successful manufacturers who have plenty of liquidity but choose to invest their money elsewhere beyond equipment.

3. Increase borrowing capacity

The typical leasing company is not looking to be a bank. In a perfect world, leasing companies complement financing that already is in place.

The most critical service a bank provides is an operating line, which is set up to handle short-term needs like paying suppliers for tooling and materials and financing receivables for 90 to 120 days.

Long-term debt, such as financing for a machine tool, is better handled with a lease or loan. A business owner should never use short-term financing like an operating line to pay for a long-term asset, such as manufacturing equipment, because it ultimately cripples cash flow.

4. Simple and convenient

Most of the inquiries I get are from manufacturers that have either just secured a contract and won some new business or landed more work from an existing customer. In both cases, time usually is of the essence and getting machinery in place quickly is paramount.

A well-organized leasing company can react to a financing request within hours or, at worst, in a few days. This type of response is not what most people experience with their banks. 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 will never hear from a leasing company except, at least in our case, when we are offering new products to our existing client base.

Doing business with a bank means monthly reporting from either an accounting department or bookkeeper, as well as annual reviews. These additional costs, which can be significant, are not reflected in the rate they charge.

5. Fixed rate

This reason does not come up as much as it should, but once a lease is signed, the monthly payment and interest rate is completely fixed. A bank or lending institution rarely fixes a rate, so over a five-year period the customer is subject to interest rate fluctuations.

We are currently in a time, due to unforeseen circumstances, of historically low interest rates, but the Canadian economy already is in recovery and the strongest it’s been since before COVID-19 hit. This will no doubt lead to increases in lending rates at some point in the future.

6. Tax write-off

Although I am not an accountant, from a taxation standpoint, equipment leasing normally is a tax-friendly option, and most of my clients write off their lease payments as an expense, no different than tooling, material, and wages.

With that said, whenever you are considering a large transaction, it is of the utmost importance to have a conversation with your accountant or financial adviser before proceeding, particularly if how the transaction is handled from a taxation perspective is the main factor in the decision-making process.

Getting new technology on the shop floor can be a very difficult exercise when bound by what can be purchased using cash. Machine tools are very expensive, and as their functionality advances, their pricing does as well. So if you are a manufacturer looking to increase efficiency (and in turn bottom-line profits) by installing the latest technology, looking at different financial options just makes good sense.

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