Sound financial investment

01 May 2008

It used to be that financing construction equipment was either via a bank or finance house. But recent years have seen equipment manufacturers become involved, the benefit being that they are closer to the market, and therefore claim to have a better understanding of buyers’needs than a third-party finance house. In addition, financing isoften offered through local dealers, making it possible to deal with a single supplier for all equipment needs, from ‘cradle-to-grave'.

Selecting a finance program depends on where a business and its operations are geographically located. Programs are often different due to local tax implications and buyer preferences. In the UK, for example, tax-based leasing is popular for financing assets, whereas German companies are often keen to own machinery at the end of the term.

Loans

Loans (Or Hire Purchase In The Uk) Are The Oldest And Most Familiar Form Of Borrowing. The Buyer Takes Delivery Of A Machine At The Start Of An Agreement And Makes Regular Repayments Over An Agreed Period. Once Repayments Are Complete, The Buyer Has Full Financial Ownership Of The Equipment.

Interest Rates May Be Variable Or Fixed At The Start Of Such An Agreement. Fixed Rates Are Generally A Good Option If The Buyer Needs To Work To A Precise And Defined Budget Over A Period Where National Interest Rates May Fluctuate. Not Only Is The Rate Of Interest Fixed, At The Agreement's Outset, But Also The Period Over Which Repayments Will Be Made.

V Ariable Rate Loans Differ By Virtue Of Repayments Varying As Interest Rates Fluctuate. Of Course, If The Buyer Believes Interest Rates Will Fall Over The Borrowing Period, Then This Is A Smart Choice.

Repayments Can Be Made Either Monthly Or Quarterly In Both Fixed And Variable Rate Agreements. Loan Arrangements Also Provide The Possibility To Pay A Lump Sum, Thereby Settling An Account Early. One Final Benefit Is That Interest Payments Can Usually Be Offset Against The Company's Income, Depending On Local Tax Laws.

Operating Leases

An operating lease is generally a tax efficient plan where buyers pay for machine usage over a set period. It appeals particularly to those that want equipment to optimise cash flow over the agreement period. Part of the equipment's capital cost is deferred as a ‘balloon’payment or residual value. The operator is therefore only paying for asset depreciation, plus interest charges. Changes in used equipment values do not affect payments because it is the lender-the manufacturer in the case of an OEM-financed purchase-that assumes the residual value risk.

Another benefit is that the OEM retains legal ownership of the machine, meaning it does not necessarily have to be recorded on a balance sheet, but rather can be treated as expense items. Where changes in a debt-to-equity ratio can damage share prices, it is a huge advantage to be without debts that might adversely impact company accounts.

Volvo Financial Services provides a variant on the standard Operating Lease package, its SureLease (Contract Hire) option, as do some other OEM's in-house financial houses. This offers all the benefits of an Operating Lease, but with the added value of a full repair and maintenance package. It enables one fixed monthly payment to cover all machinery expenditure with the exception of fuel and operator costs. Knowing those costs in advance is an advantage when bidding for new projects against competitors, who may not have key expenditure known and controlled in such a way.

Finance Leases

The Finance Lease combines elements of both a conventional Loan and an Operating Lease. A key difference, however, is the company effectively takes ‘ownership’from day one of delivery. Thus, the equipment is recorded as a balance sheet asset on the company's accounts.

Finance leases come with or without a ‘balloon’or residual value payment. These are set at the beginning of the schedule. When the repayment period is finished, the buyer may purchase the machine outright with this final payment, but this depends on the tax regime in different countries.

Residual values are typically set relatively low, meaning the final payment required is also far from excessive. This is important, as the risk with a balloon payment lies with the equipment buyer rather than the finance house.

Buyers tend to choose these schemes if they think a certain machine may prove popular with customers, the equipment is still of value when the lease has finished, or if there are benefits to selling the machine on the used market. Germany is one example of a very ownership-driven market, where customers use Finance Leases as a program to pay for the machine and ultimately take ownership.

Suitability

Selecting a finance provider depends on a number of factors. There are no hard and fast rules-offers are directly linked to the amount borrowed and credit worthiness. As a general rule of thumb, lease agreements require a deposit equal to between 10% and 15% of the equipment value, with repayment schedules set over a three or five year period. Standard credit checks will also be conducted to ascertain suitability, although in many countries it is now possible to be granted approval within a matter of hours or even minutes.

A new development from OEM-owned finance houses is the ‘Special Offer'. Manufacturers use these as a way of encouraging customers to try a new model on advantageous credit terms. A classic example is Volvo's current 0% Hire Purchase package for its BL71 backhoe loader, which the company launched in 2002, and is trying to establish in the market place.

Whatever finance programme is chosen, it is worth taking into account how construction equipment represents a sound investment. A healthy used equipment market, and strong residual values for the right product, are testimony to the strength of the construction market. Most items of larger equipment have a value for years to come, giving second, third and even a fourth generation of owner an opportunity to maximise their return on capital.

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