Consider all the facts when financing equipment

Shops often use equipment leasing as a complement to their bank.

Now that we have passed the halfway point of what has already been a very busy 2022, I thought it would be a good idea revisit why it can be a good idea to use leasing as an option when adding new equipment.

And the reasons for keeping money in the corporate bank account are no different in a slow economy than when it is booming: Cash is king. Therefore, maintaining a solid cash balance always is preferred regardless of market conditions. Here are three reasons why I recommend equipment lease financing to Canadian manufacturers:

1. An Operating Lease is Tax-Friendly

When a piece of equipment is bought outright, either in cash, by bank loan, or a using line of credit, the buyer takes immediate ownership, which means the equipment becomes an asset on the balance sheet.

From a taxation perspective, the benefits of ownership allow a company to depreciate the asset, which essentially is expensing a percentage of the equipment value to reduce operating income and, in turn, pay less tax.

However, if the purchase happens near the end of the year, the tax savings are minimal because the CRA may not allow a full year’s depreciation to be taken. When viewed from a tax minimization perspective, a favoured method to handle a transaction is to set up an operating lease.

This is a contract that allows for the use of an asset but does not convey rights of ownership. It is the leasing company that maintains ownership. The equipment is not put on the books as an asset but instead is accounted for as a rental expense in what is known as off balance sheet financing. It does not result in assets or liabilities being recorded on the balance sheet.

From a financial perspective, a company’s efficiency improves dramatically because a new, income-generating piece of equipment has been installed allowing the company to gain more sales and profits from existing balance sheet assets.

Now, there is no doubt that the lowest cost of funds will always be a bank loan, however, the differences can be minimal. As an example, if a five-year lease is arranged for a machine that is $100,000, the monthly payment is roughly $2,000. But when this same transaction is arranged with a bank, the payment may be closer to $1,900. So, when the tax savings is taken into account, the monthly difference could be less than $40.

A leasing company typically responds very quickly to these kinds of requests. For a transaction of this size, it likely will be no more than one or two business days. When compared to a bank, this can be critical because of the limited number of machines currently on the market and the need to act immediately when an opportunity arises.

2. Lease Equipment and Invest Money Where it Will Earn the Best Return

Machinery and equipment are, by nature, depreciating assets. Even the finest machine tools are at their maximum value the day before they are installed. A smart business owner uses their funds for investments that provide the greatest return, and that normally is produced by re-investing in their own business.

Many of my most successful clients are owner/operators, so not only are they running the plant and making sure good parts are delivered when promised, they also handle all the proposals, quoting, and estimating.

They function as both the sales manager and the plant manager, two roles best handled by different individuals. Depending on the business, it could make a lot of sense to hire someone or re-assign a current employee to split up these two jobs.

I can tell you from first-hand experience that business development is a full-time job, and one that can provide a great ROI. Investing in your business in this way always is a good use of funds and something that cannot be financed.

3. Leasing Allows Companies to Significantly Increase Their Borrowing Capacity

A typical leasing company has no intention of replacing your bank.

All of my clients have very good banking relationships and large operating lines, which they use for short-term debt like financing receivables, or to cover short-term costs like tooling and material. They often use equipment leasing as a complement to their bank.

They match their lenders with their debt requirements and avoid tying up valuable bank lines and working capital for long-term needs like machinery and equipment.

I also have clients that simply can’t use a bank for a large financial transaction such as a piece of manufacturing equipment because, from a financial perspective, the company’s overall value will not support the required transaction.

Buying the latest technology is a very expensive proposition, and despite the fact good equipment, when maintained properly, will run in a plant for more than a decade, it is, in most cases, a very significant cost and difficult for typical banks to understand.

We recently hired a new credit analyst who came from a chartered bank, and I got a first-hand account of how they review asset purchases. What I was told is the bank looks at every asset, whether it’s a machine tool or a trailer, and assumes they’ll recover about 20 per cent of its original value if the deal goes bad. When a leasing company with expertise in the machinery and equipment market looks at the same transaction, it knows that the recovery is a much higher percentage and therefore will approve the transaction because the perceived risk is much smaller.

While there certainly is a dollar and cents attitude when making these decisions, make sure all of the relevant aspects, such as tax implications and the internal ROI, are taken into account along with needs for increasing borrowing capacity.

Ken Hurwitz is vice-president of Equilease Corp., 416-499-2449, ken@equilease.com, www.equilease.com.