Can I really afford the new equipment my business needs?
It may seem obvious to some of us that we simply cannot afford to invest in a new computer system or a new piece of equipment for our business, if there is no money in our bank account to cover it. Wrong! If we wait until the money is in our bank account, chances are that we will never be able to afford it.
The key here lies in the word invest. If we make an investment in our business, we expect to make a positive financial return on this investment. If you take a look at the cost of the investment, and balance this with the potential return that will be generated by the asset over its useful life, then it may make sense to go ahead and make the investment.
Take an example of a piece of computer equipment that you would like to replace. The old equipment is slow, it does not do everything you would like it to do, and you need to do workarounds that take time if you are to get the output that you need. If you factor in the workaround time, the old system may in fact be costing you money whereas new equipment may generate cost savings.
A simple way to approach it is to take a piece of paper and draw a line down the middle. On the right hand side, list the expected monthly cost of the purchase over its useful life. So if it has a useful life of 5 years and the cost is $6,000, then the monthly cost is $100 (6,000 divided by 60).
On the left hand side, list the monthly time and other savings you will get by replacing the old equipment and put a monthly monetary value on this. So if time and monthly savings were $150 and you expect to get benefits for 60 months, then the total benefits before tax would be $9,000 (150 multiplied by 60). If you are entitled to tax breaks for asset purchases, then add in the monthly financial benefit to this side of the page as well.
Total up the costs side and the benefits side. If the benefits outweigh the costs, then this will validate your decision to invest. If the costs outweigh the benefits, then you may decide to wait another while before making the investment.
However, there is a caveat to this. You cannot simply raid your bank account to make the investment simply because the cost benefit analysis came up positive, even if you have an overdraft from your bank that will cover the cost of the equipment. It is a bad idea to use your working capital to fund significant asset purchases, even if you have the cash right now.
The right way to do this, once you have worked out the useful life of the asset being purchased, is to work out the cost of funding the asset with a loan or leasing facility that matches the useful life of the asset. In this way, you are paying for the equipment while you are using it, and you are avoiding a serious drag on your bank account at the time of purchase.
Bank funding has been tight in recent years but you will probably find that loans or leasing are still available for many types of equipment purchases. If your own bank is not prepared to support you, there will undoubtedly be lots of other specialist equipment leasing companies that will be happy to help you make your purchase. You may even get to enjoy tax breaks for making the investment.
In summary, for assets with a multiple year useful life, you should pay for them over their useful life. For assets, with a useful life of less than one year, pay for them over less than one year. If you expect a positive financial return versus the cost, then it is sensible to make the investment by funding it with a matching loan or lease facility.