Should they lease or purchase finance their vehicles? That was the question facing a contracting company in Nova Scotia. The answer shows how paying for business assets becomes a strategic decision, says Mike Fralick, president of Fralick Financial & Insurance in Halifax.
When Fralick was talking to the fleet manager of the contractor, the conversation turned to a possible sale of the business. “In all likelihood, it would be an asset sale, so it was important to build assets up,” says Fralick. If having equipment on the balance sheet doesn’t matter, and tax mitigation is more important, Fralick might recommend leasing.
The time horizon is another consideration for financing. For assets with long life cycles, purchase financing can make sense. Other times, the pace of technology can dictate leasing. One of Fralick’s clients has a digital press that may be obsolete in 24 months given software upgrades. “So you lease it, get the full write-off on taxes and turn the machine over,” says Fralick.
While seeking a solution that fits your cash flow and the life of your asset, look at all options for financing, says Brett Simpson, chairman of Rogers Group Financial in Vancouver. He says many owners want to separate their business and personal financial lives. Yet owners could consider using a home equity line of credit to loan money to the business from time to time. “The least expensive facility is home equity,” says Simpson.
Depending on the financial institution, there are ways to get creative too. For instance, one available option is tapping into a line of credit secured by a collateral mortgage on commercial property. So if businesses own their own building, the market value can translate into abundant room to borrow.
Should companies use retained earnings to acquire an asset or borrow based on advantageous interest rates? It depends on the time frame and how else they might invest the money, says Fralick.
Take the case of a $50,000 piece of equipment, where you could pay off a loan in 30 months at a rate of 5%. It might make sense instead to use retained earnings. Take your cash and cover the debt, says Fralick, rather than borrow and then invest your earnings. The time period is just too short to take a chance on coming out ahead on investments.
However, if you’re financing that same piece of equipment over seven years at a low rate, “I might say that’s cheap interest and we have a much greater probability of making more than 5% over the longer period,” says Fralick.
Factoring in tax efficiencies, competitiveness and business value, financing decisions can be complex, states Fralick. Weigh the full range of strategic and operational issues. “It’s rarely just a bottom-line question of dollars and cents,” Fralick says.