A look at the decisions that go into funding large capital purchases

Manufacturers are steadily buying equipment as upgrades, for business extensions, and in some cases, to meet green initiatives.

“These purchases are being made to seize an opportunity,” says Krista J. Dobronos, senior vice president and market leader at Westfield Bank. “Some manufacturers have moved into bigger buildings, which have given them more space that they’re filling with additional machines. Some are making large capital purchases because there are many tax advantages available, so companies are acting now to replace aging equipment.”

With market confidence up, businesses have shown a greater willingness to move on large capital purchases. But how that purchase is funded can be the difference between a good investment and a great one.

Smart Business spoke with Dobronos about the options manufacturers have to fund large capital purchases.

Have lending requests from manufacturers been trending up or down in recent years?

There have been steady requests from manufacturers for lending. Part of that is being driven by the tax law changes. Many service providers, accountants in particular, are reaching out to their customers to help them understand the opportunities that exist, and whether it’s a good time to buy.

Otherwise, companies that are sitting on cash might see an advantage to holding it rather than using it to buy equipment. As interest rates start to rise, companies are beginning to earn a better return on their money, so debt may be the better option when making a large purchase.

What are the more common ways manufacturers fund large capital purchases?

Typically, large capital purchases are made with term loans, but the debt type and terms will be contingent on the useful life of the equipment and whether it’s new or used.

In addition to conventional financing, there are several federal and state programs that can help fund these purchases. At the federal level, there are SBA programs for equipment loans. In Ohio, there are programs such as Ohio GrowNOW, which can be used to fund equipment as long as jobs are added because of the addition or upgrade. Ohio’s Collateral Enhancement Program helps companies that might not otherwise have the collateral to access loans, also with a job growth component. Banks can connect companies to these options.

Another option is to lease the equipment. This can be advantageous, but companies should work with their accountant to understand if it’s really the best choice.

What should manufacturers weigh as they consider making these purchases?

Manufacturers should always weigh the ROI on the purchase they’re making and determine how quickly that return might come back. This data will guide the company to the right term — say five years versus 10 years — for the financing.

Companies should also ask if the equipment they’re buying can be used to support more than one customer. Relying on one customer to make a big purchase could mean the company gets stuck with an unproductive and costly piece of equipment should the customer leave.

Also explore the efficiencies the company stands to gain from the purchase. Will the new equipment mean quicker production times, better quality, less overhead? And then calculate the savings.

The environmental impact of equipment is also part of the consideration. As more companies go green, they’re finding a significant benefit in replacing old machines with more modern equipment.

What should manufacturers prepare before meeting with their banker?

Banks are going to want to see the past three years of the company’s financials as well as projections, including how the equipment will impact the bottom line over the next couple of years. Banks might also like to see the actual quote for the equipment costs, as well as the costs of any other necessary parts for the machine. That will give the bank the full picture of the proposal.

Manufacturers should discuss financing options for large capital purchases with both their banker and accountant. The new tax laws will play a part in the equation, so it’s a good idea to get guidance on the type of structure, whether to lease or own, and how it will depreciate under the new laws before making a purchase.

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