At some point in the life of a business, there will be a need for equipment renewal, whether due to current wear, increased production capacity or modernization. Using a loan to purchase machinery and equipment can be a valuable tool in conserving a company’s cash flow. Let’s take a look at this tool and understand how worthwhile you are to use it when purchasing your own equipment. http://www.tnrovers.com/payday-loans-online-direct-lenders-teletrack/ for more.
Does my company need new equipment?
The first analysis that needs to be done is the real need for new equipment for your company. Periodically, the business owner must assess whether their current equipment continues to meet the business need. A simple way to perform this analysis is to track the production capacity of the equipment over its useful life.
If the equipment is no longer producing as it was when you financially planned your business, this is probably a good time to renew it. Another interesting way is to always keep up to date with the market and evaluate if there is any new tool with production capacity higher than your current one.
Imagine a bakery that has a machine with a production capacity of 1,000 loaves a day, at a unit cost of $ 3.00 and a unit sales value of $ 5.00. At the same time, there is a new machine on the market that produces 1,200 loaves a day, at a unit cost of R $ 2.50. By replacing the old machine with the newer one, the bakery can increase your productivity and improve your gross profit margin, as shown in the statement below.
Should I fund my equipment with a third party?
Having done this, it’s time for you to define how you will finance this purchase. There are two ways to fund a purchase: either from your own resources or from third party resources. The way to analyze what kind of resource to use should always be the same, through the cost of capital.
The cost of capital, simply put, is the minimum interest rate the entrepreneur expects to receive upon making an investment. For example, if an investor defines that he or she wants to obtain a minimum return of 10% on an investment, this alternative can be considered as economically attractive only if the investment reaches the expected 10%.
In the case of third party capital,
The cost of capital is the interest rate charged by the financial institution for the loan. In the case of equity, this rate may be interpreted as an opportunity cost, ie, the return on the best financial opportunity that the investor waives by choosing to use other resources.
In the purchase of new equipment in the amount of R $ 100,000.00, the entrepreneur has the possibility to get a loan in the same amount with annual rate of 20%.
This rate reflects the cost of capital of third parties. At the same time, the company has the possibility to invest that same amount to enter a new market where the estimated margin of return is 30% per year. This rate reflects the opportunity cost for the company. It is up to the entrepreneur to evaluate where to invest his resource.
By using own resources in their purchase, the entrepreneur chooses not to use the money to invest in the day to day of his business. If there are opportunities within the business that can have an attractive return, where the entrepreneur could use equity and the company has this cash available, why not invest in the company’s success? Now, if this capital is not available, often the cost of a loan is worth it.