In 2018, many companies increased the pace at which they acquired equipment because of favorable tax law changes and substantial year-over-year growth. In 2019, there continues to be a strong appetite for new and used equipment.
“Capital spending will remain strong and in positive territory for 2019, while credit market conditions should remain healthy,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “The time to capitalize on equipment purchases is now.”
Smart Business spoke with Altman about how to determine the best method to fund equipment acquisitions in today’s economy.
What are the factors that determine how a company finances equipment?
Companies should factor in how buying or leasing equipment will help optimize their income tax, balance sheet, cash flow and equipment situation before entering into any legal agreement.
From the income tax perspective, reviewing the alternative minimum tax position, net operating loss carry forwards, and bonus depreciation requirements are key considerations.
Balance sheet review items include managing to balance sheet and income ratios, ROE and ROA performance measurements, anticipated events that require companies to preserve cash and borrowing, and how the FASB accounting changes will alter a business’s approach.
Cash flow items include 100 percent financing to conserve cash for other needs, minimizing monthly payments, and matching payments with seasonality.
Equipment considerations should focus on what type of equipment a company plans to acquire and when it expects delivery, obsolescence concerns, and long- or short-term ownership preferences. Review all four areas to find the right loan or lease solution.
How has the current economy affected how companies finance equipment acquisitions?
In this cycle, the corporate tax rate change from 35 percent to 21 percent increased the amount of cash on hand. Companies are making more cash purchases than normal, even though interest rates and terms continue to be favorable.
Many companies that have relied on loans for capital expenditure purchases are rethinking this strategy based on whether they can use all of the depreciation benefits in addition to having to deal with limited interest expense deductions born of the Tax Cut and Jobs Act of 2017. There are strategies to maximize the after-tax cost of acquiring equipment. Conserving cash for future growth and acquisitions while entering into the right loan or lease agreement for the right situation can be a prudent strategy.
What is a tax advantaged lease and when do they come into play?
All decisions to acquire equipment have an effect on the income tax position of a company. With the Tax Cut and Jobs Act of 2017, interest expense limitations for companies over $25 million in sales are causing companies to consider tax leasing over debt in certain circumstances. If a loan generated interest expense that cannot be fully utilized, the company is not maximizing its after-tax cost of capital. Among the advantages of tax leasing is a 100 percent lease expense deduction, which could reduce its tax obligation.
Tax leasing allows a company to customize payments based on seasonality, reduce cash flows while entering into a lower cost of capital during the usage of equipment, and offers the opportunity to purchase the equipment for long-term ownership.
What are banks looking for from companies that want to finance equipment purchases?
Knowing what the capital expenditure plans are for the next 12 months and having a plan for acquiring the equipment are key for banks in determining a company’s credit needs. Banks focus on cash flow as the primary source of repayment, with an interest in the value of the collateral as a secondary measure.
Banks will also ask how this additional expenditure will improve revenue, efficiencies, and profit. In line with prudent credit reviews, historical performance, coupled with pro-forma plans, will be an integral component as companies look to form a strong bank partnership during growth or stable economic cycles.
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