Understand the financing process

Editor’s Note: Canadian Metalworking invited shop owners from across the country to submit leasing/financing questions to be answered by expert Ken Hurwitz. This is Part II of a two-part series featuring the most common and most interesting questions. Find Part I here.

Q: What determines how much financing I qualify for?

A: The simple answer is that the applicant determines how much lease financing is available to them at any one time. A lender looks at both the company and the strength of its shareholders’ personal credit to establish how much financing will be available.

A review of the company’s operating profit, working capital, and cash flow is performed to determine if the business currently is profitable and has the ability to pay for its existing loans and expenses before adding new debt.

Another factor that is looked at is the company’s debt-to-equity ratio, a financial ratio that indicates what proportion of equity and debt the company is using to finance its assets. A high debt-to-equity ratio indicates that more creditor financing (leases and loans) is being used, rather than investor financing (owner/shareholder funds).

Last, retained earnings, the profits retained by the company that are reinvested and are not paid out as dividends, as well as tangible net worth, the sum of all assets minus liabilities, are evaluated to determine the value of the company.

The manufacturer’s commercial and personal credit reports also are reviewed. These reports provide a significant amount of information, including how much credit an applicant has already been given and their repayment history.

Once all of this information has been collected, a document is prepared by the lender that details the business, the experience of ownership, and the served industry, along with a justification of why the equipment is required and what the potential benefits will be to the bottom line once installed.

This document, along with all the financial and commercial information, is evaluated by a credit analyst to determine if the application is approved, declined, or structured.

A structured approval is an approval for less than 100 per cent of the total request. Having this means that the deal is approved, but it requires a deposit or additional collateral to mitigate the risk to the lender.

Q: How far in advance of buying should I get financing?

A: This is a very important question because when manufacturers are looking for a new piece of equipment, they normally are doing so because they have just landed new work and are under pressure to get the new machine on the floor and making parts.

Typically, borrowers spend the majority of their time scouring the market to find a suitable machine at a reasonable price that can be delivered quickly and then they start the process of arranging financing.

Getting financing in place for a new machine can be as fast as one or two business days, assuming the applicant has everything required to submit an application, including up-to-date financial information.

Because a machine tool normally costs more than $100,000, potential lenders want to review the last few financial statements or tax returns and will also want to see something for the current year, particularly now given the COVID-19 environment.

I always recommend using a registered accountant from a quality firm for this. They provide a well-prepared report, which gives more comfort to any potential lender. Internally prepared reports for the current financial year may also be required if the accountant-prepared statement is more than six months old.

Once the machine and approximate cost are established, it is a good idea to start the application process. This gives potential lenders time to review the application and process the approval while giving the borrower information regarding term, rate, payment, and structure.

Q: Can I lease more than just machines for my shop?

A: Yes. There is no limit to what can be leased if it is being done for commercial purposes to support your business.

Normally, investing in new technology is just the first step, albeit the largest one, to improve both efficiency and profitability. Having the newest technology on your floor is great, but if systems are not in place to support it, then the gain could be compromised.

This is where a turnkey system can be beneficial.

The term turnkey refers to something that is ready for immediate use; a reference for which the customer, upon receiving the product, just needs to “turn the key” to make it operational. It is a complete workcell capable of running finished parts, including automation, fixtures and tooling, and the machine or machines.

A real-world leasing example of this is a good customer of mine from my days as a machine tool seller who financed two CNC lathes complete with robotic automation and a conveyor system.

The total cost for the cell was approximately $300,000 and the monthly payments were about $6,000.

Delivery time was about five months, so the customer made five monthly payments totalling $30,000 during the build time, which was far easier to manage for them considering the initial deposit alone would have been more than $90,000.

Q: What can I do if I get turned down for financing?

A: The first thing to do if you are declined is ask the lender for the reason. There are myriad reasons an application doesn’t get approved, but sometimes it can be as simple as the lender not fully understanding the industry and the inherent value a brand-name machine tool has, so they decline the transaction based solely on its amount.

Machine tools are very expensive and, on first glance, a submission may look too rich for the credit profile of the applicant. That is why it’s a good idea to work with a lender that has manufacturing industry experience.

One of the best methods to attract a lender is to provide additional collateral because it reduces the risk associated with the transaction.

Another approach is to offer a deposit. This shows that the borrower is serious about adding the equipment and truly believes that they will be successful because they are willing to risk some of their own funds.

If a sizable upfront deposit has been given, lenders know that even if the deal goes bad and the equipment is repossessed, it can be resold and a significant amount of its equity will be recovered.

Another option, when funds are not available for a deposit, is to provide collateral in the form of existing equipment that has been paid for already and is free and clear of any liens.

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