Smart Solutions for Financing Equipment When Inflation Spikes, Interest Rates Climb
by Ellen Comeaux Monitor 100 2022
Inflation and the current economy are affecting every industry, including the equipment finance industry, whose clients have had to be innovative when addressing solutions to the current and pending economic difficulties. While myriad options exist, it’s up to equipment finance companies to point these clients in the right direction.
Ellen Comeaux, Senior Vice President, Commercial Division Leader TIAA Bank
Even during the ongoing economic uncertainty, there’s a soaring demand for capital equipment. From medical to material handling and from computers to trucks, the growth spans several industries, including industrial, healthcare and technology. But for companies looking for new machinery, several challenges loom.
Inflation is hovering near a 40-year high, driving up the cost of parts, labor and, in turn, the price end-clients must pay. To fight the runaway inflation, the Federal Reserve has begun raising interest rates, but that compounds the problem. Now businesses must pay for equipment that costs more while it also costs more to finance it.
So, equipment buyers must make a difficult decision and determine how to acquire new or upgrade existing equipment in the most cost-effective manner for their business needs. Fortunately, companies today have many options for either leasing, renting or securing a loan.
Here are some things equipment finance companies can highlight for companies that want to explore available options:
Businesses of all sizes often choose to leverage equipment leasing, partly because the value comes from using the equipment, not owning it. Leasing provides increased flexibility to the user, particularly when future upgrades are anticipated. A shorter lease can minimize the financial risk of new technology quickly rendering the equipment outdated.
Leasing also has other financial benefits. It’s a predictable expenditure, as the equipment expenses simply become a monthly line item. (Companies can ask tax advisors whether that could lead to tax advantages, such as having the lease payments be considered business expenses). Strategic decisions like this could help control cash flow, allowing companies to conserve capital and reserve credit lines for other investments and operating needs.
While interest rates have risen, they’re still near historic lows. That means companies looking to lease equipment for an extended period might choose to lock in long-term rates now before they rise further. Doing that poses another tricky decision, as with supply chain challenges, it might take longer than expected to install the equipment. If that’s the case, lessees should explore options to lock in rates now and delay making monthly payments until the equipment gets fully installed. But because those companies would be agreeing to start a non-cancellable financing obligation prior to the equipment being delivered, they should first ensure they’re working with reliable equipment providers who have longevity in the markets they serve and a strong reputation for meeting their obligations to customers.
Two of the most popular leasing options are either a fair market value lease (true/operating lease) or a bargain purchase option lease (finance/capital lease). Fair market value leases tend to have lower monthly payments, they may be considered an operating expenditure and they’re a great way to mitigate the risk of technological obsolescence. Also, FMV leases may be the right choice for companies needing equipment for a short-term contract or in cases where it’s not known how long the equipment is needed. One tradeoff, though, is since companies don’t own the leased equipment, they can’t depreciate the asset, and they won’t know until the end of the lease how much it would cost to buy the equipment if they choose to keep it at end of their lease term.
Finance leases, on the other hand, are geared toward those interested in owning equipment that will be useful even after the lease runs out. This option could allow lessees to take advantage of the tax deductions that might come with bonus depreciation. These payments would likely be higher, though, because the full cost of the equipment is spread over the chosen term.
Fee Per Use
Another option is a consumption-based agreement that charges a fee for each use. Fewer lenders offer this, but it might be beneficial for companies trying to match their payments with revenue. While businesses can bundle in the entire solution for consumption models (e.g., expenses such as servicing, equipment, upgrades and implementation), that can be unpredictable and companies might use the equipment more than planned. If that happens, the cost could exceed a standard monthly payment.
For the same reason rising interest rates might prompt companies to lock in leases now, it might be best to lock in long-term fixed rates for loans. That could be particularly helpful for small- to midsized-companies facing tightened expectations from end-clients. With loans, companies own the equipment and build equity in it as payments are made. Companies might also benefit from Section 179, which allows then to deduct the cost of equipment as an expense for the tax year it is placed in service. The tradeoff with loans is higher payments than leases.
In this volatile market, cash is king. Some companies with enough capital might decide to use it for a down payment on a loan, but others may reserve that capital and set it aside in savings, where rising interest rates can help it grow. To preserve liquidity, it may be beneficial for companies to seek lenders that offer financing at 100% of the equipment value — including installation and delivery — without down payment.
Companies have long leveraged equipment financing to grow their businesses through economic cycles that were both bullish and bearish. When weighing the best options, it’s important to work with a lender that understands your business and your equipment to structure flexible financing solutions that are tailored for your company.
In an uncertain time, it’s even more important to plan and execute strategically.
About the author: Ellen Comeaux is senior vice president and commercial division leader for TIAA Bank. As a veteran with more than 30 years of experience, she leads the bank’s commercial real estate and vendor equipment finance business lines.
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