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Implementing a Major Purchase

Filed under Getting Financing. Fact checked on May 24, 2012.

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After you know pursuing a major purchase is the right step for your business, know the ins and outs of a smooth major purchase implementation.

Once you've decided that a particular major purchase or project is right for your business, the issue becomes, what's the best way to implement your decision?

While many of the details of your project plan will be specific to your particular business, some of the more common questions business owners face are the following:

Buying or Leasing

If the major purchase you're considering is a car, truck or some fairly standard office equipment, you may want to consider leasing your equipment rather than buying it. Leases for standard equipment are easy to arrange with suppliers and, in fact, there's a great deal of competition in that business, so you may be able to whittle down the costs even further. However, be aware that leasing will frequently cost you more in the long run.

If the project you're considering is a new office, store, warehouse or other business facility, leasing the facility from the owner may also make sense at first, until you can afford to buy it. Actually, almost anything can be leased, even specialized production equipment, store fixtures, and custom-constructed real estate, although these kinds of deals are more frequently arranged through third-party financing companies.

The starting point for your decision-making is, once again, the projected cash flow statement you've worked up showing the dollar benefits of the project, and the costs under the options you're considering (in this case, leasing vs. purchasing).

Evaluating whether it's better to lease or to buy can be easily done by performing a net present value analysis of your cash flows under both alternatives, and comparing the results you get. The alternative with the lower NPV will be the cheaper alternative in the long run. However, factors other than cost may influence your decision as well, and you should consider the advantages and disadvantages of leasing.

Tip

As a very rough rule of thumb, leasing is often cost-effective for items like cars, computers, and other equipment that decrease in value over time, and will be used for about five years or less. With property that will be used for more than five years, the long-term cost of leasing will often be greater than the cost of purchasing the asset.

With property that will increase in value over time, such as real estate, leasing should be considered a last resort for those who can't afford to purchase. Owning appreciating business property is the key to long-term wealth.

Tips for a Smooth Implementation

Major purchases include numerous little details you may forget about or dismiss as they take focus off the big picture. But paying attention to these details can mean a much better implementation of your project.

Don't Fall for Expensive Service Contracts

Service contracts that are pitched to you when you buy a piece of business equipment are often a good deal for the supplier—but not for you. In most cases, the amounts you'd spend on a service contract is wasted money. This is especially true in the case of generic equipment that normally carries a warranty anyway—if something is going to go wrong, it will generally do so in the first 30 to 60 days, when your warranty should cover the problem.

There may be situations where service contracts are a good deal. For example, if the equipment was custom-built and is expected to need regular maintenance in the future, if spare parts and knowledgeable labor will be hard to find, or if getting repairs done immediately is extremely important to your business's operation, you might decide to purchase a service contract on a trial basis.

Compare the NPV of the Loan Payments

If you have decided to purchase a major asset and are planning to take out a loan, a good way to compare the options available is to do a net present value analysis of your cash flows under the various interest rates and terms your local lenders have available. Your cash flow projections should consider the loan payment outflows as well as the revenue inflows that would result from your purchase or project.

Negotiate the Payment Schedule You Want

While you're thinking about the appearance of your cash flow budget after you complete the purchase or project, remember that you may be able to structure your loan payments to coincide with your expected cash inflows from the project. For example, you may be able to put off the first loan payment for several months, until you have begun to receive a revenue stream from the project. Depending on how strapped you are for cash, you may even be willing to accept a higher interest rate in exchange for this privilege (especially if your loan agreement allows you to pay off the loan early and refinance without a prepayment penalty).

Seek Financing from Suppliers

Often the best source of financing for a major equipment purchase is the manufacturer or supplier of the equipment itself. Suppliers have a vested interest in qualifying you for the loan — if you don't qualify, they may not make the sale. Moreover, because they believe in the quality of their equipment, they're more likely to accept it as loan collateral than a bank or finance company would. And, they may be more willing to finance a greater percentage of the purchase price without requiring a hefty down payment.

Considering Used Equipment

If you do decide to use third-party financing (like a bank or finance company loan), you may find that you can finance a greater portion of the purchase price if you opt for used equipment. Why? New equipment depreciates so quickly that its value in a foreclosure sale may be as low as only 50 percent to 60 percent of the purchase price, after just a few months. Because the bank won't want to finance more than it can easily recoup by foreclosing and selling the equipment, you may have to make a very substantial down payment on the item. However, the price of used equipment is generally closer to the fire-sale value, so the bank may more willing to loan you most, or even all, of the purchase price.

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