Don’t pay too much

Interest rates might be at an all-time low, but making a poor decision on commercial finance can still be a very costly mistake. Alan Johnson reports.

Commercial finance can be a daunting task for many manufacturers. However, there are some basic areas that when considered will make the task a lot easier on the cash flow of the business and give peace of mind to the business owner.

Ken Richards, director of Interlease, one of Australia's largest business finance broking companies, says there are five key areas manufacturers should consider before entering into a commercial finance agreement.

Preserve working capital

Richards says for almost every business, the most important component is access to sufficient working capital.

"Some of the most profitable businesses from a EBITDA perspective have been brought undone by having limitations on their working capital; during growth phases, acquiring new businesses or when the market changes," he said.

While in some cases it can be tempting to purchase capital equipment from surplus funds or by using overdraft facilities, Richards warns that this is not always the best option.

"It may be better to use those funds to pay creditors, secure discounts or to fund the expansion of the business."

Plus he advises manufacturers to consistently focus on ensuring their clients pay promptly, and in full.

"This is a very important area for a company's ongoing success, and is an area many overlook and effectively means you are providing finance to your customer" Richards told Manufacturers' Monthly.

Choose the optimal finance structures

When looking to finance capital equipment, there are a number of issues to look at when choosing the optimal structure and term.

Regarding cash flow, Richards says manufacturers should choose the option that will best match equipment finance cost with the income from the asset.

"In some cases the income may be seasonal or may vary across the life of the asset. Therefore manufacturers should make sure that the finance can be structured, as best as possible, to match the expense to the income expected to be generated."

Richards points out that companies should also take into account that some assets will become obsolete much quicker than others.

"For example, computer hardware will most likely achieve technical obsolescence far quicker than a machining centre. So the decision as to what term to choose to finance equipment needs to take into account each individual asset type.

"Plus different assets are deemed to have different depreciation rates and a poor selection of finance structures can reduce the tax effectiveness of capital equipment purchases, for example a machining centre running one shift for five days is not being worn out as quickly as one running three shifts over six days," Richards said.

Minimise security offered

For the financing of commercial equipment many manufacturers turn to their bank, which in many cases has funded other purchases for them, such as property.

However Richards says companies need to remember that the bank's overlying objective is to provide the best outcome for its shareholders.

"As such, a bank will seek to obtain the maximum amount of security it can for each dollar it lends. If a manufacturer thinks like a bank, he or she will quickly understand why the banks try to get as much security as possible, and never want to hand it back," he explained.

Most manufacturers when starting out offered real estate security to obtain bank facilities. While this may have been necessary initially, Richards says manufacturers should look to have their surplus security released once the business achieves a greater financial position.

"For this reason, we recommend that a business be valued annually by a financial expert such as the company's accountant," he said.

As a general rule of thumb, Richards says manufacturers should use anyone except their bank to finance capital equipment.

"It is vital companies only use available funds and collateral security for working capital, and not to purchase equipment or other self-funding assets and they should not over expose themselves to any one financier as this may limit the funds available.

"As a company's exposure increases with any one financier, they will increasingly want to dictate terms and how and when the debt is repaid."

Richards warns that banks offer customers the products they like with little regard to what the individual customers needs are or what the equipment is, how it will be used and how long it will be retained.

"Additionally, the bank almost always has property security and most businesses in Australia are required to provide an All PAPS, the equivalent to the old fixed and floating charge and each of these documents and subsequent finance documents cross link everything to improve the banks position.

"Many business owners don't truly understand what this means and what control this gives the bank over their businesses and historically this charge remains well past the repayment of debt," he said.

Choose the optimal financier

Richards says it is important companies have access to a range of finance providers so they can choose the best option for each equipment type and for the company's needs.

"For example, when a manufacturer wants to purchase more than one machine, it is important to have the flexibility to be able to use multiple financiers.

"This will give the company greater access to funds, but also the ability to choose the structure it wants for each machine."

When importing equipment, Richards says it is important the financier can pay deposits and progress payments to the overseas supplier without the requirement for security or the need to use the company's overdraft.

"Plus always ensure the finance providers can finance the full range of assets including; computer software, tooling and dies, office and factory fit-outs," he said.

Build your fortress

It is no secret that successful businesses have great people on their team and have access to a range of external experts who are working to help achieve goals. It is not different with commercial finance.

Richards says it is vital manufacturers use a truly independent finance broker who is an expert in business and equipment finance, with an understanding of the industry and equipment.

"Too often businesses are relying on their bank, a mortgage broker or someone who has limited under­standing of the optimal way to finance business equipment and machinery."

He points out that the finance market is competitive and companies should only use someone who understands all of the options.

"Companies should always work with their accountants throughout the year to make sure they are making informed business decisions and to help them to decide which financial solutions will best suit their needs."

In summary, Richards says ­manufacturers should choose their clients, suppliers and business ­partners wisely and resist the urge to put all their eggs in one basket. 

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