This is an uncertain economy, especially for capital-intensive companies that rely on equipment and specialized machinery. Increasing or upgrading that equipment is an expense and a risk that many decision makers are avoiding. Instead, they should be thinking seriously about acquiring equipment through financing.
Ironically, we have the uncertain economy to thank in the form of low interest rates and numerous incentives such as tax breaks and rebates. Favorable rates and incentives reflect government efforts to spur recovery and growth. That’s why it’s an historic time for equipment financing. In my 25-plus years in banking, I can’t recall a period when rates and incentives were so simultaneously positive.
Equipment can be purchased or leased. Which is the best way to go? It depends primarily on the residual value of the equipment at the end of the financing term. Buying is usually the best choice for equipment that will have residual value. This typically involves obsolescence. If a particular piece of manufacturing or transportation equipment will still be working in five to ten years with reasonable maintenance and within reasonable performance margins compared to newer models, then it has residual value. Personal computers are an example of equipment that frequently does not satisfy this test as new products regularly outstrip older machines in function and performance.
The buying-versus-leasing decision often rests on initial costs and interest rates. In the past, leasing represented a lower cash outlay at the start of financing. Today, there are numerous scenarios for 100 percent financing and the inclusion of installation costs when buying, eliminating the down payment, and leasing time-honored advantage. Today’s low rates also have minimized the cost differential between buying and leasing. In the end, don’t make any automatic assumptions about buying versus leasing. Examine both side-by-side.
Beyond what your bank can do with rates and terms, the government is trying to make it as easy as possible to finance equipment. Bonus depreciation is one example of such an incentive. In the first year of owning an asset, the Federal Government allows you to take depreciation on 50 percent of its value; after that, you can depreciate the remaining value under regular conditions. Energy credits are another version of federal, state, and local governments’ eagerness to get you to acquire equipment. Systems with the proper certification for energy efficiency can entitle you to tax breaks depending on the equipment and your geographic location. As with all tax matters, consult your tax professional.
Low rates and ample incentives make equipment financing especially attractive, but always remember the primary reason for acquiring equipment is to improve your business’ productivity and profitability. Forecast increases in output and quality and decreases in costs for labor, transportation, or raw materials that will result from new equipment. These figures will define your true cost of equipment ownership and, most importantly, the equipment’s impact on your overall business.
This is an historic time for equipment financing, but like all good times, it’s not likely to last. Interest rates have nowhere to go but up. Nobody knows when or how much, but an eventual rise is probable as inflationary threats grow due largely to fuel costs. At the same time, incentives such as tax breaks and energy rebates are expensive. Government denies itself revenue in exchange for stimulating the economy with such givebacks. With “austerity,” the watchword from Capitol Hill to your local city hall, we can expect incentives dwindle as governments strive to match budgets with their income.
We have a saying in banking: “What are you waiting for?” That’s right. When something is so apparent, bankers act just like “regular people” and urge you to take action. Equipment financing is one of these exciting issues in 2011. Talk to your business banker (and your tax pro) about the options and opportunities.