Is there a right time to upgrade your equipment?
Keeping your business's competitive edge and profitability on track can come down to the efficiency of your equipment. Christine Long reports on what you can do.
NAB'S SME survey, released June 2006, reports that just over half of the companies questioned (51%) expect profits to improve over the next year compared to only 14% forecasting a deterioration in profits. In an environment of economic change and uncertainty, how can you keep your competitive edge and ensure you are in a position to deliver long-term business profits?
According to NAB's Head of Economics, Jeff Oughton, there are a number of factors that are affecting businesses operating costs. "Primary drivers to these changes are the rapid increases in commodity prices, in particular, oil, which can affect the cost of manufacturing production as well as delivery of materials and goods across the economy," says Oughton. "To date, many businesses have beared much of these cost increases. There is, however, an increasing trend to pass these on to customers, as the prices of oil and other commodities remain high and demand is sustained.
"Rising manufacturing and transport costs in conjunction with a shortage of both skilled and unskilled labour is driving up business wage bills as employees enjoy a strong bargaining position and demand pay rises to meet the rising cost of living. Last but not least, higher interest rates are also raising debt servicing costs."
Is it time to upgrade?
To remain competitive and deliver an edge in the market in an environment of rising operating costs, it may be worthwhile auditing your equipment and to consider upgrading or updating it. Upgrading equipment can achieve significant operational efficiency, particularly when you have a planned, sustainable update program for your business vehicles and equipment. This can result in increased outputs requiring fewer resources such as staff, raw materials and energy. Ultimately, this may have the affect of lowering your operating costs and increasing your margins, leading to a competitive advantage.
"We've really focused on driving internal productivity improvements which have provided spin offs in terms of our ability to service customers and support profits," reports a small business service operator in NAB's SME survey. You may also like to consider reviewing your IT equipment. What are the efficiencies you can gain by reviewing your business model, your systems and how your staff interact with each other and with your customers?
However you should not consider upgrading your business equipment without understanding the cost-benefit analysis of your decision. You will need to weigh up the financial outlay over a period of time against the costs your business is facing, your competitive position and the forecast demand for your product or service. This is clearly an area that can be considered with your accountant or financial adviser.
Equipment is not the only area to consider as an operating cost, you might also consider changing your business vehicles to more efficient, fit-for-purpose models.
Structure your payments
If you make the decision to update or upgrade your operational vehicles or equipment there are a range of asset finance options that allow you to spread the cost over several years. Payments can generally be structured to suit the particular income and revenue generation patterns of the business and some products allow for "balloon" payments at the end of the agreement, which allows you to lower your monthly costs to help manage your cash flow.
There are three main asset funding alternatives available: equipment loans, commercial hire purchase and finance leasing.
David Taylor, Head of Asset Finance at NAB explains their similarities. "The main things that are common to all three are we will fund 100% of the purchase price and we can offer very flexible payment structures."
And their differences "come down to what is the appropriate product for your business based on the tax and accounting treatment." Taylor adds: "We find that many businesses choose this type of finance as the asset itself often acts as the security, which means that the business does not have to put up other assets as collateral."
Equipment loans
These products have become more popular since the introduction of GST in 2000, according to Taylor. In this case the bank provides a loan for a piece of equipment and the loan is secured by a mortgage over the equipment, known as a chattel mortgage. At the end of term when the loan is repaid, the mortgage is discharged.
The frequency of payments can be matched to your business cash flow and operating cycle. For instance, agreeing to pay off a loan in three years, when the piece of equipment is going to be used to efficiently generate revenue for six or seven years, may not be the best use of your cash flow.
"In the case of an equipment loan the customer would get a deduction for the interest and they would get a deduction for the depreciation provided it's being used in the business," says Taylor.
Commercial hire purchase
This is a similar product to the equipment loan in that the business is entitled to claim depreciation and interest. However, the difference is the bank owns the asset.
"Because the invoice is made out to the bank we don't need to take a mortgage over it," says Taylor. With hire purchase you enter into a contract agreeing that you will purchase the asset and take ownership when you make all the payments.
Because of the difference in the ownership of the asset during the hire purchase contract, there are some differences with GST.
Finance lease
A finance lease is a third option. In this case, the bank owns the asset and the business is not obliged to take over the ownership at the end of the lease.
Because the bank owns the asset, it claims the depreciation but the business is able to claim a tax deduction for the entire amount of the rental that they pay rather than just the interest component.
There is a residual amount owing at the end of the lease and the business is responsible for that amount, says Taylor.
"What happens in 99.9% of cases is the customer pays the residual amount owing and we transfer the title to the customer."
Should the business return the vehicle or equipment to the bank and it is sold, any shortfall it is payable by the business.
Seek advice before choosing a product
The tax treatment of the various funding options can be quite different. In some cases only the interest component is tax deductible whereas in the case of a finance lease the entire repayment is deductible.
Because there can be variations in the GST treatment as well, David Taylor, Head of Asset Finance at NAB suggests SMEs should seek advice before selecting one of these products.
"With all these products we would recommend that customers talk to their accountants to make sure that they have selected the right product for their business."
Christine Long is a finance writer who contributes to The Sydney Morning Herald and Australian Financial Review.