Many if not most construction companies are started on a dime. You save your money, maybe get friends and family to invest, buy the cheapest backhoe you can find and get busy.
But at some point, you’re going to need to grow and that means buying new equipment. When you get to that point, unless you’re just drowning in money, you’re going to have to take out loans or leases to acquire the equipment.
To get the best value from loans and leases you don’t need to be an accountant or a tax specialist – that’s expertise you can hire. What you do need is to have a clear understanding of where your business is today financially and where you want to take it in the future. Then get your accountant and tax advisor to sort through the financing options with you.
Getting the right financial instruments is more than just important. It can make or break your company. You may not think that the interest rate differences between a loan, a capital lease or an operating lease are significant – and usually they’re no more than a few percentage points between them. But when you’re financing hundreds of thousands of dollars of equipment, a less-than-ideal arrangement may mean you have to bring in thousands of dollars of extra work every month just to stay even with a competitor who acquired an identical machine at the same price using the right financial product.
Every company’s situation is different. As your company grows and changes, the type of financing you need, maybe even the source from which you get your financing is going to change as well. But until then, here’s what you need to know about equipment financing.
Conquering cash flow
Even if you have enough money on hand for continuing operations and emergency needs, sitting on a big pile of emergency cash is like stuffing money under the mattress. It’s losing value every day, instead of working to make you more money. You don’t want that sum to get too large.
By acquiring your equipment with the help of custom payment plans or revolving credit lines from finance companies and dealers you can keep that unused cash pile from getting too big without endangering your cash flow.
Revolving lines of credit
With revolving lines of credit the dealer or finance company can advance you money against the equity in the equipment you currently own or other assets. You can buy and sell equipment in and out of that line and use it for operating expenditures without asking the finance company or dealer as long as you have available funds on this line.
Revolving credit lines can be tapped to take advantage of unexpected opportunities or to pay for problems that crop up such as a blown engine or other emergency repairs. In either case you can spend the money as needed and pay it back in installments. Doing it this way means you won’t have to worry about making payroll or changing your bonding profile because of big, unforeseen expenses.
Some dealers have also recognized the value of issuing credit cards and open accounts so that purchases of parts can be done by trusted employees and the charges put on the revolving credit account without excess paperwork or authorization. Many also authorize the credit cards or revolving accounts at any of that manufacturer’s dealers, regardless of location, so you can do business in multiple locations without needing multiple authorizations.
Custom payment schedules
Equipment dealers and finance companies know that construction is seasonal and payments to contractors rarely come in regular monthly installments. Accordingly most lenders today will structure your loan or lease with either seasonal payments or skip payments – so you pay during your working season.
These arrangements can be custom tailored to meet just about any type of cash flow. You can pay monthly installments, or annually; or pay during the busy season – when cash flow is good – and skip payments in winter or the off-season.
Are you looking at tight cash flow on a long-term project that pays a bonus at the end? Many lenders offer split rates where you pay zero interest for the first two years and standard rates for the remainder of the loan or lease. The bottom line with these customized deals is that you can get a payment plan tailored to your unique business and cash-flow needs.
Who to turn to for financing
There are two basic categories of financing for heavy equipment – “independents” and “captives” in the industry lingo.
The independents are institutions like banks and lending companies. These are not tied to any one dealer or equipment manufacturer, hence the term independent. They lend money to a wide variety of businesses and needs.
Captive financing is financing offered through an equipment dealership for the purchase of that dealer’s or manufacturer’s equipment or product support. Some dealers offer their own in-house financing. Others participate in programs put together by their OEM. The latter tend to be more comprehensive and include extras such as insurance and revolving accounts.
The independent financing sources cite their wide range of financial services and ability to finance all brands and types of equipment as two reasons to do business with them. In addition to leases and loans their financial products include checking, saving, investments, insurance and mutual funds just to name a few. Today many also offer custom payment schedules and revolving lines of credit.
The biggest difference between independents and captives is that independents will finance the purchase of multiple brands of equipment from different OEM dealers, whereas the captives strictly finance their own brand of equipment and some ancillary, non-competitive brands.
Both groups say they will finance any qualifying contractor regardless of the size of the company, but as a general rule the larger independents are better positioned to provide services for larger customers. Big contractors with established track records and multi-million dollar financing requirements have access to a lot of different companies that want to lend them money and are in a better position to get competitive rates from independents. Startups and small contractors, on the other hand, are more constrained by the availability of capital, and are more likely to look to the captives as their best source.
In assessing an independent source of financing for your equipment needs, look for one that has some expertise in the construction business and construction equipment. These are much more likely to offer custom plans and lease-buyback arrangements and understand equipment values. A company with a long track record in your community is also desirable.
Just like the independents, the captive financing available through dealers in recent years have expanded their offerings to include a wide variety of custom plans, revolving lines of credit and insurance programs. Many dealers also bundle service and maintenance programs, repair costs and commercial-card convenience. Most will also help you with the financing of other pieces of equipment (such as trailers and attachments) as long as it’s not from a competing brand.
But where the dealers shine is in offering financing terms on equipment the manufacturer wants to move. Whether it’s to draw down inventory or capture market share, they often give below-market or sometimes even zero interest rates on select models of equipment or product support.
Choosing a type of financing
There are many different ways to pay for a piece of construction equipment. If you want the lowest possible cost of acquisition, pay cash, in full, up front. You get all the depreciation benefits of ownership and you don’t pay a dime in interest.
As good as this sounds, cash out of pocket is not often used for one primary reason – cash flow. Most businesspeople prefer to make this kind of cash available as working capital to pursue other opportunities or serve other areas of the business. If your company is earning a 10-percent return on assets every year, it makes no sense to tie up your cash in machinery when you can finance the equipment for 5 to 8 percent a year. To preserve some working capital and liquidity, most contractors finance their equipment in one of several different ways.
Installment sale. An installment sale is another term for a conventional loan. You give the dealer a down payment, take possession of the equipment and make a series of equal payments for 36, 48, or sometimes 60 or even 72 months. You build equity with each payment and retain the depreciation and tax write off advantages of ownership.
Leasing. A lease in its simplest form is almost like a long-term rental. In a lease the lessor (a bank, leasing company or dealer) retains ownership of the equipment, while you make payments for the privilege of using it. Monthly payments are usually lower than payments for an equal amount financed with a conventional installment sale.
There are two basic types of lease. In a finance lease or capital lease you make the payments over a period of time and then have the option to purchase the machine at the end of the lease. The lessee (contractor) retains the tax benefits of depreciation and builds some equity.
A tax lease or operating lease has even lower payments than a finance lease and may provide the option of buying the equipment at the end of the term, extending the lease for an additional amount of time, or returning the equipment to the dealer. You don’t get depreciation with a tax lease but you can treat the payments as a business expense.
You’ll find a lot of different combinations and variations of finance and tax leases. Again, the right choice for you is something you need to review with your accountant and a tax lawyer if necessary.
Buy now and save money on your tax bill later
In addition to the checks the government is mailing out to taxpayers this summer, The Economic Stimulus Act of 2008 offers businesses of all types two attractive reasons to buy capital goods before the end of the year.
The Act’s bonus depreciation provision enables you to depreciate an additional 50 percent of the cost of a qualified business asset bought and used in 2008 in addition to the regular MACRS (Modified Accelerated Cost Recovery System) depreciation on the remaining 50 percent of the equipment cost. This gives you an opportunity to significantly increase your current depreciation deduction by an amount that would otherwise have to be spread out over the life of the machine.
And for taxpayers who purchase less than $800,000 of equipment during the 2008 tax year, Section 179 of the Act almost doubles the equipment expenses you can deduct from your taxes. Previously you could only deduct $128,000 per year in equipment expenses. This year you will be able to deduct $250,000.
Taking advantage of either or both provisions may help to lower your tax bill this year. But as with any decision like this, consult your accountant and tax lawyer. For more on the details of the Act and for a calculator that lets you see how much you could save, go to the website: www.depreciationbonus.org/.
The following people were interviewed and contributed to this article. For more information about the companies and services they offer visit the websites listed below their names.
Tim Pratt, division manager, for Wells Fargo Construction
Greg Giauque, marketing manager, Wells Fargo Construction
Hartono Tanuwidjaja, CFA, sales support manager, Cat AccessAccount
Michael Webster, senior merchandising consultant, Cat Finance
Rick Schulte, director, Doosan Global Finance
Scott Harris, U.S. director of sales, CNH Capital
Jay Harris, program manager, Takeuchi Financial Services