Following a strategy for saving will make your next big equipment purchase much easier.
How did you pay for the last big piece of equipment you bought? And how would you want to pay for the next one?
You may think that for big-ticket items – a new truck or some other piece of machinery, say – it’s inevitable that you’ll have to get financing. And it’s true there is an advantage for many businesses to stretch payments over time.
But that’s not the only way to go. When it comes to acquiring major pieces of new equipment, you have three alternatives.
Financing is, of course, one of them: After a down payment, you take out a loan for the balance of the cost of your purchase and pay it out over time, with interest, typically with monthly payments.
Another is leasing: You may have a large up-front payment – depending on the terms of your specific deal. In either case, you then have monthly payments, as with a loan. The difference is that after a fixed amount of time you can walk away from the transaction or buy the product at a price usually set in advance.
But some business owners opt for a third way: cash. You do that for small purchases all the time. And with careful planning you can even use it for high-priced items.
Balancing your interests
Which alternative will serve you and your business best can depend on a lot of factors – not just the obvious ones.
If the equipment is expensive and your need is genuinely urgent, financing may be your only option. Even the most profitable small business is unlikely to be able to just peel off tens of thousands of dollars or more on the spur of the moment to replace a machine that broke down unexpectedly.
And if you have another reason to want to hang on to cash – to cover expenses and payroll during a predictable, upcoming seasonal slump, for instance – you have another incentive to borrow for a major purchase.
Leasing offers some of the same benefits as borrowing, but it also has a downside. While a lease often has a lower up-front cost, it’s likely to be more expensive overall than a simple loan, especially if you want to keep the product when the lease expires.
Leasing has some other distinct advantages, though. The main one is that it can help you guard against obsolescence.
If the product you need is expensive and is also one frequently upgraded thanks to rapid technological advances, you might think twice about owning it outright. By leasing, you could simply upgrade to the newest model every few years.
Cash on the barrel
Some business owners, though, prefer to keep finance debt to a minimum. And the best way to do that is to pay cash when you buy something new.
Even if you do finance or lease equipment, you still need to be saving for the down payment or other up-front costs, as well as the buyout cost in the case of a leased product that you choose to buy at the end of the lease term – just as people hoping to buy a house someday save for the down payment, even if they know they’ll have to take out a mortgage.
Households save for the future in other ways – and more should, as personal finance experts will no doubt attest.
But so do municipalities. Equipment replacement funds are common on the line-item budgets of many units of government. They are sometimes required by law. In Wisconsin, the state Department of Natural Resources oversees local municipal sewer collection and treatment agencies and issues the permits required for operation. One condition of those permits is for the municipality “to properly operate and maintain the facilities, including maintaining adequate funding.”
For municipalities that receive loans from the state Clean Water Fund Program to help cover the costs of treatment facilities, an equipment replacement fund – or ERF – is also a requirement. The DNR rule specifies that the fund is to be used “only for expenses incurred for equipment related to the municipality’s wastewater treatment works or urban runoff treatment works” – including both the cost of the equipment as well as the costs of installing it.
The rule further specifies how much the community must set aside based on the cost of the equipment that it covers. For communities with $1 million or less in the assets covered by the rule, the equipment replacement fund balance must be at least 50 percent of that value. As the amount increases, the required percentage falls; communities with more than $30 million in relevant assets must keep 5 percent of that value in their ERF. As you can easily see, that indicates those higher-priced items are probably still going to be purchased through a loan, but the regulation is aimed at making sure the agency has enough for a down payment.
Make it a habit
Private business owners aren’t governed by that sort of regulation, of course. But that doesn’t keep you from abiding by its spirit.
That takes planning and discipline, although there’s no great mystery to it. We’re simply talking about setting aside cash consistently, in a fund or account designated for that purpose, instead of spending all your profits or distributing it to the owners.
You can do that any way that works for you. One simple approach is, with every price you set for a service, simply build in a fixed percentage to cover future maintenance and replacement of your assets. When you get paid, put that particular sum aside into your designated fund.
If you wanted, you could tie the size of that added factor directly to the kind of job and thus the nature of the equipment that you use, but that’s a lot of work and isn’t really necessary. Picking an appropriate flat percentage for everything is going to be easier.
Your tax advisor or accountant will be able to help you figure out just how much – and also how to make sure that it gets properly accounted for so that it’s not treated as taxable profit when it hasn’t been distributed.
Just like a municipal sewer utility, your business depends on quality equipment to do the job efficiently and deliver value to your customers.
Making sure you can adequately maintain your equipment and replace it when the time comes ensures you live up to that standard.