Leasing lessons for today's jobshops

Recent changes in the manufacturing market may affect the way jobshops view capital acquisitions.

Recent changes in the manufacturing market may affect the way jobshops view capital acquisitions.

As large automotive and aerospace companies push more responsibility onto suppliers, jobshops may need to take a closer look at their capital acquisitions and financing options. In order to make the best decisions, they must be aware of market conditions and know what options are available to them.

Market conditions play a big part in helping companies determine what options are best for them. Bill Roden, from The Associates Manufacturing Equipment Group (formerly LCA), Dallas, says that companies are taking more precautions these days. "Large companies have changed the way they're going to suppliers for parts. They've consolidated suppliers as well as gone international in sourcing, and that's changed the environment for jobshops. Many were caught with excess equipment when this phenomenon started to accelerate early last year."

Roden reports that companies are looking at short and long term leasing rather than purchasing to fill orders for specific parts, jobs, or contracts.

Unfortunately, many smaller shops don't take advantage of the opportunities that leasing provides because straight financing is easier to understand, according to leasing experts. "Most of our business (90%) involves dollar option leases, which are really straight financing options — not leases. We offer it because our customers demand it. However, this option doesn't offer the flexibility and benefits of real leasing," says Roden.

Ed Hetherington, senior vice president of CIT Group, Atlanta, notes that educating smaller shops about financing options has always been a priority for his company, too. "However," he says, "smaller shops still have pride of ownership, which may keep them from taking advantage of the benefits of leasing. But some of the market changes may force them to rethink their options."

Brian Runkle, vice president of machine tool sales for GE Capital Advance Machinery, Louisville, Ky., and Michael Short, director of strategic marketing, at GE Capital Commercial Equipment Financing, Danbury, Conn., agree. The two report that smaller shops are typically prone to cash-oriented purchases, while larger companies tend to use more sophisticated evaluative measures for justifying capital purchases and leases because they have the internal resources like in-house accountants and finance departments to rely on.

"But with suppliers' increased levels of responsibility," says Short, "smaller shops are forced to make that balance between cash preservation and capital management."

Leasing is one of the ways that companies can achieve that balance. "First of all," says Bill Purcell, president of the Machine Tool Finance Group of U.S. Bancorp, Tualatin, Oreg., "it eliminates large down payments that banks might ask for on loans, so it helps preserve cash flow. Secondly, at the end of the lease term, the lessee can buy the equipment or return it and buy new equipment."

In addition, a lease gives customers the option to walk away from the machine and go on to a newer, improved, faster, or bigger model. Leasing through a niche lender that understands the business rather than dealing with a banker who doesn't understand the value of the equipment also makes for an easier transaction. An extra benefit is that these transactions are now completed in a matter of hours as opposed to days. "Lastly, depending on the company's situation, leasing can offer tax incentives that purchasing cannot," remarks Purcell.

Get to know your banker
Not all transactions will be through a finance company, though, so companies also need to establish good relationships with their bankers. Bill Purcell suggests that subcontractors to the automotive industry prepare themselves by having good working relationships with their banks, as they can provide the working capital lines of credit needed to fund the tooling setup process. "A lot of small shops think that if sales are increasing, that's all they need to provide the cash for growth," he says. "Many small shops don't want to borrow on lines of credit or think they don't need them, but growth takes capital, and you need working capital lines of credit to fund that growth. Account receivables do not turn around fast enough to provide the cash needed to run a company."

Purcell recommends that companies have a line of credit established so that when the opportunity knocks, they can bid competitively on a project. He also suggests that owners be proactive with their financial presentation to the bank or equipment finance lender. "Make sure you have the financial statements, tax returns, and all the financial reporting in order, especially if you want to borrow larger amounts. Be prepared to answer questions that are asked concerning the cash flow of your business. It will give the lender a better feeling about lending you the money."

Gretchen Perkins, vice president and senior business development officer for Fleet Capital Corp., Detroit, adds, "It is important to provide your banker with good historical financial statements so he can assess the historical performance of your company. You will also need a good budget for the coming year and, ideally, for the next three to five years. A projected set of financials for the coming year will give your financing source a clear idea of what is planned and where you are going."

Perkins also recommends that companies provide a good description of what they want to finance, especially when dealing with a banker that may not understand the value of the equipment or the nature of the business. "Use your finance partner to help you find the best way to finance those projections, whether it's tooling, fixed asset acquisitions, new projects, or buying a competitor," she suggests.

What are your options?

The following are some financial options that are available to companies:

True or tax leases. A company can lease equipment for an agreed term and then buy the equipment for a fair market value at the end of the lease. The lessor has the rights to depreciation, while the lessee benefits from off-balance-sheet treatment and passes the risk of equipment obsolescence onto the lessor.

Tax lease purchase. This tax lease is designed to let companies purchase the equipment at a pre-arranged date for a stated value by the customer. Until the customer decides to purchase the equipment, however, off-balance-sheet treatment is available. But companies may still walk away from the equipment if they so choose.

Lease purchase. This option is designed for customers who ultimately want to own the equipment. All depreciation belongs to the customer, and the asset is shown on the customer's balance sheet. The lease purchase is advantageous because companies pay sales tax over time as well as a low initial down payment.

High yield debt. Companies with revenues in excess of $100 million can access the high yield debt market. There is no principal amortization on this debt until the expiration of the term whereupon the principal repayment is due in full. Companies only pay interest for a period of generally 10 years.

Senior debt bank financing. Senior debt bank financing includes a wide variety of flexible structures from cash-flow based loans to asset-based loans as well as working capital options that let companies leverage their assets and cash flow to generate cash for new and incremental costs.

Selling or recapitalizing. Companies can sell a portion of their company to a strategic investor or a private equity fund that can inject some necessary capital in exchange for part ownership of the company.

Mezzanine finance. Mezzanine capital is in between the debt and equity on a balance sheet. It is generally subordinated debt that carries a fixed interest rate, is more expensive than senior debt, and may carry fractional ownership of the company.

Asset management

GE Asset Management Services offers manufacturers asset management programs for equipment, including financing new and refurbished equipment, turnkey management, service contracts, retrofit and refurbish programs, and equipment decommissioning and disposition.

These programs are designed to help manufacturers balance short-term cash needs while preserving financial and operational flexibility for future needs. As GE Capital advises, preservation of cash and optimizing asset usage, not asset ownership, are key to financial strength and overall business survival.

GE uses a model, based on the traditional cost-of-ownership model, that assesses equipment throughout its entire life cycle. By examining acquisition, service and upgrade, and disposition, GE can give customers detailed planning and acquisition options.

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