Any company that is thinking about the implementation of large operations improvement projects, automated systems, and/or new technologies needs to know about the potential advantages that financing them by leasing can offer. These types of projects are large in scope and purchase cost. Return on investment (ROI) is a key issue in any large purchase. Market forces are pressuring companies to achieve faster ROIs. Leasing can drastically improve ROI, preserve cash flow, and offer other financial advantages to the users of large systems and complex capital equipment.
Most integrated materials handling projects today take more than a year to develop and install, and average about two years to achieve their ROI. A company may have to wait bewteen two and four years before the full expected return on investment shows up on its bottom line. Although the productivity gains and cost savings are considerable, many companies hesitate to implement projects due to time considerations.
In today’s market there is ever-increasing pressure to improve profits immediately. Automation projects are a hard sell to upper management and financial people, despite their acknowledged benefits. The large outlay of cash for something that will not give a positive accounting benefit for two or four years greatly hinders commitment.
Many operations people feel they are in a ‘Catch-22’ situation. They need to cut costs and be more efficient, but they cannot justify a project financially within the (short) terms that their financial people are comfortable with. Thus the project dies and a ‘band-aid’ approach is applied to a problem that requires a serious commitment to solve.
A different approach
There is a way most companies overlook to justify these improvement projects and obtain instant ROI on capital investment. It’s called leasing.
Although the forklifts that interface with these systems and the buildings that house them are leased with great regularity, leasing is a much under-utilised method of financing large systems. Cranes, conveyors, carousels, storage rack, and automated guided vehicles are almost always purchased. This equipment is often modified or customised to meet the user’s specific needs and the cost of disposing or re-selling it is prohibitive. Forklifts and buildings have re-sale values that are easily assessed and are readily resold.
Other factors have greatly influenced the purchasing methods of integrated systems. Part of the reason is human nature’s resistance to change. Leasing is considered an exotic means of financing a system. Another is that in the past, banks and financing institutions did not have an understanding of how these systems work and the great returns they can yield. Many financing companies are still hesitant to lease anything that does not have an easily assessed resale value.
Times are changing
Times are changing, however. On the user side many companies are in dynamic industries that are growing rapidly. In the USA in particular, strategic planning three to five years out is almost impossible. A major cash commitment to purchasing assets is not the best use of cash. Public companies are faced with meeting forecasted profits every quarter, or face a rebuke from Wall Street. There is great pressure against sowing seeds for tomorrow, taking lower earnings now, and reaping greater rewards later. Investors have not shown that type of patience. The USA has enjoyed a robust economy along with low and stable interest rates. This offers a favourable environment for leasing.
Every day new and more complex technologies are introduced into the supply chain, the plant and the warehouse floor. Although storage racking and conveyors have changed little in the last five years, software, information systems, barcodes and other parts of a materials handling system have changed greatly. Many companies must constantly upgrade their capital equipment to stay competitive.
In banking, a number of financial institutions are starting to understand the value that materials handling improvements and automation projects add to client companies and are more eager to help arrange leasing packages. These institutions work with the end-user and integrator (or systems provider) to define the value that the project will provide to the end-user. Then the institution will create a financing package based on credit-worthiness, return on investment, and the value added to the operations.
Let savings pay and the cash to flow
Cashflow is a key issue for many companies. Savings from the implementation of a new system can pay most or all of the lease payments, often with money left over that goes right to the bottom line.
Leasing requires a minimal up-front investment. By spreading your payment out over part of the useful period of the equipment, you do not take a large hit at the front of the purchase. You can preserve your company’s credit line and cash reserves for other important items and resources.
Leases offer greater flexibility in their structure, terms and payment disbursements than loans. The majority of the expense in cash purchasing and loans come in the front end when you have received little or no return from your improvement project. Leases can be structured such that the majority of the expenses come in the back end, when you have received years of payback. Most lessees do not require companies to put up other parts of their business as collateral, as they would for a loan, because the leased equipment is enough to secure the deal. In many ways leasing is a safer form of financing to the end user.
Avoiding the taxman
Leasing may also offer substantial tax advantages. Leased equipment is kept off the balance sheet. It may not be considered an asset, thus it may not be subject to asset taxes. Laws differ widely from country to country, however (and within the USA from state to state), so please get proper tax advice.
Lease payments can be deducted from your revenue, thus reducing your taxable income. With certain types of lease, 100% of the annual equipment (lease) cost in a given year can be written off. This is especially helpful for equipment and technologies where obsolescence is a factor; computers, software, and enterprise systems have a useful life of less than three years.
Your company can choose to own the equipment at the end of the lease or turn it in, to retrofit your plant with new equipment. Depending on your company’s accounting methods or philosophy, you may capitalise and/or depreciate the system. Leasing enjoys many of the same tax advantages as a direct purchase.
One other consideration is that a lease can include value-added services such as maintenance, insurance, training, disposal of equipment, even trained operators themselves. This all adds flexibility to a company’s operations and can bring additional offerings to its customers.
Advantages that add up
It must be remembered that the end-user benefits by the use of the equipment from the production that the equipment yields, not by the ownership of it. Materials handling equipment does not increase in value over time and is not easy to resell. Ownership has no relevant value, but use does; the productivity that modern equipment provides can transform a company.
Implementing an integrated system financed by a lease can yield excellent paybacks and immediate returns. Leasing allows companies to better match time and technology. A lease may also offer potential tax and accounting advantages as payments are considered an operating expense and are not reflected on the customer’s balance sheet. The flexibility, hedge against obsolesence, and possible value-added services a lease offers are powerful advantages that a growing company in a dynamic market can use. Leasing, however, is not for everyone in every situation.
Every operation is unique, accounting practices differ, each system offers distinct returns, and companies calculate their return on investments differently. Sound judgment of all options is a foundation of good management practice.
Leasing is a wise consideration in funding operations improvement. For companies that want to improve their efficiency with the shortest ROI possible, leasing is a viable method to finance the improvement your operations without encumbering your cashflow.
