Seek financial advice for year-end machine tool purchases

We have arrived at the end of 2021, and there’s still plenty of business to discuss. Things are starting to feel back to normal: The market has been very busy, the Canadian Manufacturing Technology Show (CMTS) came off without a hitch (albeit on a smaller scale), and manufacturers are quickly working to get financing approvals in place so they can have equipment on their floor before the end of the year.

The struggle now is equipment availability, which was the driving force behind a downsized CMTS. While COVID-19 wreaked havoc on the supply chain in almost every industry, as the world gets back to normal, it’s a good time to talk about year-end purchases and how they are handled on a company’s financial statements.

Leftover Budgets

Even before the pandemic happened, manufacturers tended to put off purchases until the fall because these investments are quite significant, and they tend to want to see how the year goes before making a buying commitment.

Also, during the early part of the year companies often are too busy to allocate the necessary time to research and source the right piece of equipment. But as the year comes to a close, manufacturers may be under pressure to purchase a new machine because budgeted money needs to be spent (or it will be lost going forward) or they were fortunate enough to find an available machine that suits their needs.

Machinery sellers also know now is the time to sell equipment, because January and February traditionally are slower sales months.

If the machinery is in stock anywhere in North America, it can be delivered and invoiced in a matter of days or a few weeks, so getting the purchase into the current year is easy. There are, however, times when a machine may need 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.

Even if a machine is crated on a factory floor in the Far East, it still takes several weeks to get to Canada, so travel time should be considered when trying to get a piece of equipment delivered before year-end.

Financial Record-keeping

I’m often asked how to handle a year-end purchase from a financial perspective. When a piece of equipment is bought outright, either by cash, bank loan, or line of credit, the buyer takes immediate ownership, and the equipment becomes an asset on the balance sheet.

A standard balance sheet has three parts: assets, liabilities, and ownership equity (the difference between the assets and the liabilities).

The benefit of ownership is that it allows for depreciation of the asset, which is a fancy way of reducing earnings, and, in turn, paying less in taxes. This is a big motivation for getting the purchase on the books before the end of the year. However, if the purchase happens near the end of the financial year, the tax savings are minimal because Revenue Canada may not allow the full year’s depreciation to be used.

It is very important for business owners who are contemplating a year-end acquisition to have a conversation with their accountant before any purchase order is issued. This honestly is important whether it’s a year-end purchase or not.

Try an Operation Lease

Based on my experience, a preferred method to handle a year-end transaction is setting up an operating lease.

Accountants classify equipment leases into two main categories: capital leases and operating leases. A capital lease means taking immediate ownership of the asset, while an operating lease is a contract that allows for the use of an asset but does not convey any rights of ownership. The lending institution, in fact, maintains ownership of the asset.

The equipment is not put on the books as an asset, and the corresponding lease payment is accounted for as a rental expense in what is known as off balance sheet financing. Operating leases have very appealing tax incentives because the payment is expensed like any other cost, such as tooling, material, and labour. Therefore, the operating income and profitably of the entity is reduced by the full amount of the payments, which results in tax savings.

Another benefit of the operating lease is that no additional assets or liabilities are recorded on the balance sheet. This means that the company’s financial efficiency improves dramatically because it has a new income-generating piece of equipment, but the number of assets hasn’t actually increased.

Last, and most important, most manufacturers have financial covenants with their banking institution that must be maintained, such as a debt-to-equity ratio, total debt, and minimum working capital. This becomes relevant because if equipment is added in the form of a capital lease—meaning both the asset and liability are noted on balance sheet—it easily can throw off these ratios, which could result in the business no longer complying with its banking agreement.

These are some basic ideas for how transactions, year-end or otherwise, can be handled from a financial perspective. And, once again, let me reiterate the importance of having a discussion with your accountant or financial adviser before proceeding with any capital purchase. They are the best experts for providing both short- and long-term strategies for handling investments.

On a personal note, I want to thank Joe Thompson and Canadian Metalworking for once again making this space available to talk about machine financing. Whether you just came across my column this month or you’ve been following it for the past eight years, my hope is you have enjoyed reading it as much as I have enjoyed sharing some of my experiences within the manufacturing industry. Keep well and stay safe.

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