What's the best way to acquire equipment?
Some contractors pay cash for their equipment because they avoid interest and monthly payments that way. Others prefer traditional financing, assuming that installment loans are the least costly alternative. However, while there are advantages to these methods in specific situations, all contractors should be aware of something called the "total cost of ownership."
What does the total cost of ownership entail?
The total cost of ownership includes such factors as the Time Value of Money* (TVM), taxes, your Internal Rate of Return (IRR), and more. Construction industry associations estimate that a contractor needs to average a 15% IRR to remain in business for the long term. Those contractors who fail to average a minimum of 15% IRR generally go out of business.
Naturally, if you're spending money that doesn't need to be spent, your IRR might not be as high as you would like. To prevent that from happening, you'll need to know your options.
This table allows you to do a preliminary comparison of the cost of an installment loan, a lease, and paying cash.** For cost comparisons, 15% IRR is assumed.
*Time Value of Money calculations compensate for Future Value. The Future Value method adds investment earnings to cash flows. This allows you to see what the value of today's money would be worth if you received a specific investment return and helps determine what your money is worth now, compared to what it will be worth as it's paid back.
**The information contained above is intended only for general illustration purposes, and is not offered as legal, tax, or accounting advice. This information does not consider taxes, depreciation, the half-year convention, expensing the lease payments, interest deductions, etc. Loan rates, lease charges and residual values vary based on structure credit worthiness. Always discuss your equipment acquisition plans with a qualified accountant.
***Assumes 2 advance lease payments
The intent of the above example is to encourage you to do a thorough comparison when considering your acquisition options. Always discuss your equipment acquisition plans with a qualified accountant.
