Equipment Financing: A New Day, Same Question

by Nelson Henry

How will you pay for needed equipment? Henry offers a few tips

Nelson Henry is senior vice president at Texas Capital Bank (texascapitalbank.com) in Dallas. He can be reached at 214-932-6835.

It's a time-honored question. You need equipment, but how are you going to pay for it? The answer must be carefully considered before making any equipment acquisition. Accounting, tax, usage, cash flow and a host of other variables factor into the final decision. The following are some key areas to explore prior to making your decision.

Know your finance source As the old adage goes, "the who is as important as the what.'' Chances are you have done business with the same bank for many years. Then you get an offer that looks good. Before doing business with a new source, check it out thoroughly. Competition is good, but make sure it is good competition.

Ask questions There is no such thing as a dumb question, and "trust me'' is not an answer. Fully understand the terms of the deal and read the small print (including return conditions, if any).

Know your financial condition If you want the best lease or loan, current financial information is essential. While some lenders are collateral based, most look at cash flow. If you hit a "bump" during the recent period, know why and explain it up front. You don't like surprises in your business dealings--neither does your lender.

Have a good accountant All equipment financing is not created equal. A lease may be a lease in name only. Depending on the structure and the end of lease options, it may really be a loan. Or a lease may be for tax purposes, but a loan for accounting purposes. It can be confusing; talk to a CPA.

Know what you want to accomplish Do you want ownership? Do you need the equipment to be off your balance sheet for bonding or due to financial covenants? Can you utilize the tax benefits? If you know the answers, equipment financing can be tailored to your needs.

Advantages of leasing The right lease situation may offer certain advantages over buying. The biggest is the financial flexibility it can give contractors.

Let's look at a dilemma many contractors face periodically. Backlog indicates the need for $250,000 in new equipment, but available cash and credit only provide a $200,000 allowance for equipment. Do you settle for used equipment, rely on more expensive short-term rentals or sacrifice something else to make the purchase?

Financing through a lease can help balance the usage and cost of equipment. Leasing makes sense when the equipment used creates a return that exceeds its cost. Leasing allows a company to set a fixed monthly payment that creates an anticipated return exceeding the payment.

Leasing can affect liquidity, allowing cash to be used as a reserve or for other purposes. Having cash allows a construction company to be more competitive in bidding. The ability to keep cash ultimately gives a company an edge on the competition and helps to ensure long-term profitability.

Leasing conserves bank credit lines, which can be hard to establish, especially with the current credit crunch. With equipment being leased instead of bought, those lines of credit can be used for inventory, accounts receivables, staffing, emergencies and other non-equipment uses.

Leasing is not subject to market fluctuations and interest rate increases. Monthly payments can be negotiated up front with a fixed rate secured for the life of the lease, making it much easier to project cash flow and budgets. Since lease payments apply to the use of the equipment and not ownership of equipment that consistently depreciates, the cash savings can yield a return that fights inflationary pressures.

When structured properly, a lease agreement can give a company the best tax benefits. With The Economic Stimulus Act of 2008, there are two things you need to know:

•MACRS Depreciation is for equipment placed in service before the end of the year and provides for a 50-percent first year allowance.

•Section 179 allows contractors to expense up to $250 million of equipment purchases (up from $128 million) in the current year subject to certain limits. If you aren't in a position to fully utilize the tax benefits of MACRS Depreciation, then your decision to lease could be pretty straightforward.