In recent years, many machine shops have experienced a significant decline in sales; compression of margins; increased competition; exportation of machining and manufacturing demand; difficulty in obtaining working capital and acquisition financing resulting in operating losses; and an erosion in tangible net worth. Those shops that have remained profitable and experienced upward trends have several common characteristics: experienced and disciplined management, a diverse customer base, no significant customer concentrations, proper leverage and stringent cash flow management.
A challenge all equipment buyers experience is determining the best means to fund an equipment acquisition: cash/equity, a bank revolving line of credit or an equipment loan. Equipment financing is especially difficult during lean economic periods, when a prudent businessperson needs to monitor and forecast cash flow needs and availability to remain solvent.
All three acquisition payment methods entail both advantages and disadvantages. Cash purchasing is simple, requires no third party intervention and alleviates a buyer from future debt/rental payments—yet a cash purchase may adversely affect a company’s solvency. Using a bank working line of credit availability is another simple funding method that requires no third party intervention. The bank line of credit financing method typically offers a competitive, variable rate loan, yet it may adversely affect a company’s access to funds needed for operational growth, cause business flow interruptions and impact daily working capital requirements. Leasing has become the most common method of funding equipment needs.
The Changing Equipment Finance Marketplace
The equipment finance marketplace has changed considerably in the last decade. As a result of consolidation, industry specialization and contraction of capital markets, machine tool buyers are left with fewer options to find financing sources in the traditional bank and finance marketplace. This has led to the growth of captive finance companies owned and operated by either a manufacturer or a distributor. Captive vendor finance companies provide finance products and services exclusively to their parent companies’ customers. Most progressive manufacturers and some of the more prosperous distributors are providing equipment financing as an extension of their selling services in order to promote acquisition.
Captive vendor finance companies provide convenient, creative and alternative finance solutions to equipment buyers. These companies offer distinct advantages over banks, finance companies and brokers. They have an understanding of the industry and equipment, the intended use of the equipment, customer credit profiles and the specific customer equipment applications. Furthermore, captives are able to offer a variety of finance products tailored to meet specific customer needs.
Many different finance options are now available. These include a loan, capital lease, finance lease, operating lease, off-balance sheet lease, tax lease, non-tax lease, promissory note/security agreement, skip payments, step-up or step-down payments, and many others. The variety of product options can often be confusing. To simplify the process, buyers should consider two financial concerns prior to selecting a finance product—tax appetite (the need for depreciation deductions to reduce actual tax paid) and cash flow.
If the buyer seeks the depreciation benefits of ownership, a non-tax lease, lease purchase, finance lease, loan or capital lease may be the product needed. Conversely, if the buyer has no tax appetite, prior or current losses, restrictive loan covenants regarding increased borrowing/leverage, or need for short-term utilization, then a tax lease, operating lease or off-balance sheet lease may be the product needed.
Once the lease product has been identified, the term and payment structure can be developed to meet the borrower’s cash flow needs. Other features of the lease such as rate, down payments, balloon payments, deferrals, commencement terms, prepayment penalties and guarantees are then typically negotiated based on the customer’s credit strength and specific needs.
“Skip payments” and flexible credit acceptance programs for equipment acquisitions on an application-only basis are in very high demand. A skip payment structure provides a payment deferral of 30, 60, 90 or even 180 days, allowing a customer to generate cash from the use of the equipment. The application-only credit approach provides a quick and easy way to fund the purchase of new equipment up to $250,000, without financial statement disclosure, based upon a buyer’s historic payment performance and character.
How One Builder Gets Creative With Leases
The majority of Makino’s lease structures are boilerplate 60-month term, lease purchase agreements with ownership transfer at lease expiration for $1.00. However, the company has also been asked to provide a few creative lease and rental scenarios.
Recently, for example, the company was asked to deliver machines to a tier one automotive supplier seeking temporary use of horizontal machining centers to qualify for a Production Part Approval Process (PPAP). This industry standard verifies that statistical methods and process controls have been implemented and have been proven effective. The machines had to be in place to receive this approval. If successful with the PPAP and contract award, the machine shop sought a long-term lease or a fixed purchase price option. If unsuccessful, the customer wanted to return the machinery without further obligation.
To accommodate the customer, Makino agreed to a sell price and set up a short-term rental allowing the customer to perform the PPAP. At expiration of the rental period, the customer was given the option of returning the equipment with no obligation, purchasing the equipment at the fixed price with a portion of the rental payment credited toward the purchase or opting to continue to lease the equipment.
In other cases, Makino has offered to refinance existing assets to lower a customer’s overall monthly payment obligations and incremental debt rate; facilitate like-kind exchanges or trade-ins; assist in the refinance of working capital lines of credit; and ship consignment machines into the customer’s plant while awaiting the delivery of a custom-engineered manufacturing solution. These examples show how the machine tool builder is trying to play the role of financial partner that banks no longer fill. The builder’s understanding of machine tools, the industry and customers’ needs put the builder in a position to create innovative funding options.
Funding the acquisition of machine tools is always an urgent issue. For a number of companies, distinguishing themselves in the marketplace with exceptional machine tools provides an edge that is vital to their survival. Meeting their cash flow goals and determining short- and long-term acquisition funding solutions are essential. The health and growth of the machine tool user and the machine tool builder are mutually dependent. Programs such as machine tool financing allow a builder not only to support the user, but also to build a competitive and supportive marketplace.
About the author: Chris Lyle is the customer finance manager at Makino in Mason, Ohio. He can be reached at (800) 552-3288, or at email@example.com.