Imagine yourself being the owner of a company. Your director of sales comes in your office and says: “Sir, we are unable to compete in the market because we are selling on a much higher price than it is offered by our competitors.” You called your costing manager and asked: “What is the problem? Why do we have such a high cost of production?” He replied: “Sir, our machines are getting older and outdated. We need new and improved machines so that we can produce at a lower cost”. What will be your reaction?
I know. You will immediately think about the capital required for purchasing the equipment for your factory. Right? We knew. You call your finance manager and said: “Do we have enough budget to replace all of our equipment?” Your finance manager said: “Despite the fact, we do have money in the bank, but it is not advised to take out that money and invest in equipment upgrade. At least not all of them. Instead, we should go for Commercial Equipment Loans options for that equipment, which are the most expensive but can yield more production for us.”
You got impressed by your finance manager. But wait! Do not jump into equipment financing and learn about the pros and cons of equipment financing.
WHAT IS EQUIPMENT FINANCING?
By the name, it is evident that equipment financing is a type of financing in which a borrower receives the money from a lender to buy equipment upon mutually agreed payment terms. The equipment could be:
Office desks and many more.
HOW DOES EQUIPMENT FINANCING work?
As we know, in most of the debt, borrowers have to give some collateral as a guarantee or security to the lender that if he is not able to pay him back, the lender can take that thing to compensate the remaining outstanding amount. Similarly, in equipment financing, the equipment itself collateral, and if the borrower defaults, the equipment is given or taken by the lender. Simple right?
But wait for the CEO. Let us see the pros and cons of equipment financing in detail.
PROS OF EQUIPMENT FINANCING:
Let us start with the positives of equipment financing that how can it be a good option for you. So let us see them in detail:
1. Ownership of equipment: The best part is, you can partially own the equipment at the time of purchase, and full ownership will be acquired at the end of full loan payment with interest. Hence without spending any money in the beginning, you can own the equipment. It is a viable option if you are taking it for that equipment that possesses long shelf life or is not highly dependent upon technology.
2. Tax reliefs: Since you are a business owner, I know what you are feeling right now. Tax relief!!! Wow!!! It is amazing. But wait and let me clear this point for you. You will eventually get tax relief, but this will be due to changes in your income statement and balance sheet. When EBITDA (Earnings before Interest, Depreciation, and Amortization) will be lower, it will decrease your taxes, and hence you can have a tax relief too.
3. No sudden cash flow out of business: Remember what your finance manager said? He said to go for financing for the equipment which costs more. Because it will require a huge amount of cash flow out of the company, which might have an impact on a company’s daily routine. He is right in it. Having those equipment financed will result in saving that cash outflow for the time so that you can think of creating some ways to increase the cash inflow and have a stable financial position for a suddenly rainy day.
4. No collateral: The best part of equipment financing is you do not have to find any collateral to give for getting the loan because of the equipment itself as collateral. Hence your other assets are saved from being taken away from you if your default.
5. Sales can experience boom: Imagine you opt for the equipment loan, and you now have the fastest machine, which allows you to lower your cost by 35%. This means that you can now offer the product at a lower price to your customers without compromising on quality. This might or will have an impact on your sales, and this can increase your sales to an unexpected level. Hence taking a loan can be a great option if this is the result of your decision.
6. Speed of equipment purchase: Imagine that in your bank, you have $50,000/- and the equipment is $45,000/-. It will not be wise to have only $5,000/- in your account and run the business. So you now have to wait for at least three months to buy the new machine. However, you can opt for the equipment financing and get your equipment right now.
But wait! Nothing in this world is good. Equipment financing has some cons as well, so let us see them too before you jump into getting your equipment financed.
CONS OF EQUIPMENT FINANCING:
Equipment financing does not have just positives. It also has some negative impacts on your business. Let us see them what they are:
1. Owning the equipment: Do not be shocked. It is in the positives as well but also in negatives too. The reason is, it was positive because you can use the machine as an owner but negative because since you have not paid any money for buying the equipment. You cannot claim the complete ownership of the equipment, and hence the fear of equipment being taken away from you will always be there.
2. Higher interest rate: Companies do not wait for months to just get the money to finance the equipment. They tend to get it much faster than other type of loans. This leads to lenders charging more interest rate.
3. Overall expensive equipment: With an equipment loan, you might end up paying a higher amount than the real value of that equipment. This is mainly due to the higher interest rate you give to the lender. Also, the machine will depreciate over time, but you might be giving money on the real value of the equipment, which was at the time of purchase.
4. Restricted for equipment only: As the name suggests, the loan is specially designed just for financing the equipment purchase. This means that you cannot use the borrowed money for payoff any other debt or even purchase some inventory.
WHAT SHOULD BE YOUR DECISION IN THE END?
Equipment financing is no doubt a great option for a business to get the equipment without taking the money out of your business, but this does not mean that it is perfect. It comes with some pros and cons, which you must consider before opting for a loan.
You are and are not the owner of that equipment. You can use the equipment as the owner and pay for the maintenance of the machine, but you cannot sell the equipment as you do not possesses it under your ownership. Also, the machine is the collateral. This might sound attractive that no collateral because the machine itself is the collateral, and a lender can take the machine back if the borrower defaults.
No matter what you say, as you are the owner of the company, you have the end wording. We have shared the pros and cons of commercial equipment financing. So it is all up to you what you want to do. But remember, if you are qualifying for the loan, it does not mean that you should apply for it. It can backfire badly for you, so make the decision wisely.