It is important to have flexibility in the way you finance assets in order to implement an effective financial structure. Patrick Gaskins explains the different factors to consider and why it’s important to make plans based on what is occurring and not what might occur.
When you think about putting together a finance structure that accommodates changes in the economy, there are a number of factors you need to take into consideration. Those include asset cost, equipment specification trends, used asset values, inflation, changes in variable operating costs, interest rates and utilization.
The variable expense associated with the asset’s use, depending on the incremental cost of the variable, will have a direct impact on whether you want to accelerate or decelerate the replacement cycle.
Fuel costs and interest rates are two good ways to illustrate this point. When the cost of fuel goes to $4 per gallon, the impact this expense has on the total cost of operation (TCO) becomes much greater than when the cost of fuel is at $2 per gallon. This increase in variable cost will impact the evaluation of the asset’s life cycle based on potential efficiency gains on new assets. If interest rates increase significantly, the fixed cost of a new asset may become much higher than existing assets, which will have an impact on asset life cycle.
Reacting to these changes is one thing, but how do you plan for unknowns? The simple answer is that you need to have some flexibility in the way you finance your assets. You can set yourself up for success based upon what you know today, along with historical trend analysis.
However, if tomorrow turns out to be different than what you predicted, you need to have flexibility from a financial standpoint to move in and out of assets based upon all of the factors I mentioned. Rigid financing start-to-finish, or ownership, doesn’t allow you the same flexibility you would have with many leased or usage based financing programs.
By tailoring your financing programs to accommodate market variables, you will allow for many of the future unknowns. Nobody has the perfect crystal ball when it comes to so many variables and how they will impact the future operation of an asset, but the first step is to identify all of the “what if“ items and make sure you have a reasonable plan to adjust to the change.
By constantly evaluating your asset performance and financing each year or even each quarter, and making minor course corrections, you will develop the flexibility to accommodate change. Wholesale changes in how you finance business operations is not a recommended practice. What may appear to be a spectacular savings in the here and now may not be the case three to five years from now.
I want to offer one note of caution: make sure you are basing your plans on what is actually occurring and not just talk of what may occur. This is especially important when there is a change of leadership. There has been a great deal of talk about how under the current administration we would see a more favorable business climate. To date, there have not been any wholesale changes in policy. We are still following the policies that were enacted by the previous administration.
While you can hope there will be changes, acting on that hope is like playing the lotto to make your business plan. Again, you need to rely on historical trends over a 10-year period to see whether they have increased or decreased. Then based upon that historic view and today’s economic conditions, you can make informed decisions.
Stick with the facts and make sure you have a good mix of financing instruments and you should be able to weather and plan for most economic changes.
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