Frigrite Africa Rental

 

 

 

 

When to finance equipment?

There is a common perception that one should only finance something if you don’t have the capital available to pay cash.  Therefore it is assumed that only businesses that cannot afford a cash purchase should use finance.  The logic is that cash is a cheaper method of purchasing because you don’t incur interest charges as you would with finance. 

 

The reality is if you are buying an asset that loses significant value over a relatively short period of time (about 5 years or less), paying cash is the most expensive option.

 

 

 

This is Why:

 

For most businesses, cash is a scarce resource. So using your cash in areas that will allow your cash balance to appreciate, rather than depreciate becomes critical. Cash purchases should only be considered for appreciating assets such as stock, property (can be turned many times over a few years).

 

The opportunity of cost of cash – “What you could have done with it”- is what makes it an expensive option. For the reason many large corporates although cash-flush will buy appreciating equipment and finance depreciating equipment.

 

In addition financing assets that are used to generate income allows the entity to be cash positive with immediate effect. Usually, the revenue generated from the equipment far exceeds the monthly lease expense. Hence the business is not in a cash negative position until a future breakeven point is reached.

 

The most popular finance structure, in this regard, is an operating lease or rental. This allows monthly payments to be treated as a monthly expense – consequently, no debt is reflected on the balance sheet. In addition, operating leases typically do not require a deposit, are fully tax-deductible and facilities usually don’t affect any existing banking lines.

 

Consider this:

 

  1. Customer A purchases fridges and a telephone system for his restaurant, costing R500k.  He uses his available cash in the bank for this purpose.

 

Customer A’s 500k is tied up in his equipment and will depreciate to, say 50k after 5k years.

 

  1. Customer B purchases the same equipment for his restaurant but uses the financing option.  He pays 12k per month but retains his 500k cash balance in the bank.

 

Customer B uses his 500k to buy and sell stock or alternatively purchases an appreciating asset.  At a return of 15% p.a. his 500k doubles after 5 years.  He also has continued access to the funds in the event of an emergency.

 

In short.

 

  • The price of cash is linked to its opportunity cost- what you could have done with it.

  • Use your cash to purchase appreciating assets.

  • Use other people’s cash to purchase depreciating assets

 

 

Dave   |   Cell: 082 056 2707   |   Email: dave@frigrite.co.za

© 2015 by Frigrite Africa (PTY) Ltd 

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