When purchasing new equipment, considering your payment options will determine your future profitability.

In today's competitive sheet metal and HVAC contracting environment, acquiring new equipment for your business can be time consuming and costly. Here are a few ways to make equipment and service truck buying a less painful and more cost-effective process.

The three types of capital items that sheet metal and HVAC contractors typically purchase are:

• General sheet metal and HVAC equipment such as press brakes, plasma cutters and other related equipment.

• Office equipment such as phone systems, copy machines, computers, software (such as accounting and estimating software), furniture, etc.

• Service trucks, including service bodies and box trucks with specialized interior-shelving packages.

There are three main ways to finance your equipment acquisitions:

1. With cash - sometimes called "working capital" - generated from your business.

2. Borrowing money from a bank - conventional financing or other financial institutions.

3. By leasing instead of purchasing.

All of these methods have positives and negatives that must be considered by business owners or managers. Often, an independent leasing professional, accountant, tax adviser or financial consultant can assist in evaluating the options for financing equipment and service vehicles.

Using cash generated from your business is possibly the simplest method for acquiring equipment. There is no interest expense when using your own money and you fully own the equipment the day you write the check.

However, there are a number of negatives when using your own cash to purchase equipment. Companies often use up valuable working capital or bank credit lines that then can't be used for other purposes such as paying employees, subcontractors, suppliers or even the owners themselves. Paying with cash also has tax implications, since most capital equipment must be depreciated over a number of years, leaving a mismatch between expenditures for the equipment and the ability to write it off.

Finally, there is the "opportunity cost" of not having the cash available for such things as purchasing another company, bidding on a major project or expanding your business, all of which requires money for materials and labor.

Heading to the bank

Obtaining a bank loan to purchase equipment is common. Local banks often offer competitive interest rates and can sometimes give you a break on fees if you have your company's operating accounts with it.

Remember though that applying for a bank loan can be time consuming, depending on the bank's credit standards and process to approve the loan. Business owners are often expected to provide personal guarantees as well. That puts your personal assets at risk should the business have problems in the future. Adding bank debt will also affect your company's balance sheet and could affect its reputation with credit-reporting agencies.

Bank interest rates often float along with the prime interest rate, resulting in principal- and interest-payment fluctuations. This can make budgeting and predicting future costs difficult. Most banks will also expect you to provide detailed financial information on a monthly or quarterly basis. Most banks will only finance a percentage of the total cost of the equipment or vehicles you purchase. As a result, your company will still need to use some of its cash to pay for a portion of the equipment.

By using a revolving credit line secured by your firm's receivables and inventories, you can finance equipment acquisitions as long as you expect to have sufficient collateral to continue to support it. However, using a revolving line of credit to buy equipment may prevent you from having enough money available on the credit line to cover other needs, such as the time between when you have to pay suppliers, subcontractors and employees, and when your customers pay you. Revolving credit lines also charge floating interest rates, adding to the uncertainty of the final cost of the equipment.

Leasing instead of buying

Equipment leasing is rapidly gaining popularity as a financing method for new and used HVAC equipment. Independent leasing companies that specialize in working with HVAC and sheet metal contractors often have knowledge and expertise that can help you find the best equipment pricing, vendors and financing options available.

With a lease, you are essentially paying for the equipment over its useful life through a series of fixed payments. At the end of the lease's term, you have the choice of either returning the equipment to the leasing company or purchasing it for a previously agreed-on price. The price can range from the estimated market value of the equipment when the lease expires to as little as one dollar. During the lease period, payments are fixed and will not fluctuate with changes in interest rates. Many leases are also not included in the company's liabilities for financial-reporting purposes and so do not affect the balance sheet or financial ratios. Lease payments usually are considered an operating expense, allowing its deduction from company income for tax purposes.

One of the largest differences between leasing and conventional bank financing is that you can often finance 100 percent of the cost of the equipment under a lease. This includes such items as sales taxes, software, service contracts and training. The costs of these additional items can often be rolled into the regular lease payment. Lease approvals often are very quick and sometimes can be done online for well-established companies.

Types of companies

When looking at leases, know that there are "captive" leasing companies and independent ones. Captive leasing companies are usually subsidiaries or close affiliates of equipment manufacturers and dealers. These firms were established to obtain additional profits for their parent corporation by financing the equipment they manufacture. Equipment salespeople receive incentives to bring business to these "preferred" leasing sources. An independent leasing company, on the other hand, does not have an affiliation with a particular manufacturer and therefore has no incentive to promote a particular equipment brand or financing arrangement. An independent leasing company can often shop a deal to a number of different funding sources to get the best deal for a company's particular needs.

Another option that is growing in popularity is the lease line of credit. This is similar to a bank line of credit, giving you the ease and flexibility of drawing down funds on an as-needed basis. This can be used for both equipment and service vehicles. This further reduces the time and administration associated with multiple lease contracts. Contractors who qualify for such an arrangement enjoy all of the flexibility associated with a bank line of credit combined with the financial and tax benefits leasing may provide.

Making choices

However, leasing isn't right for every company. When comparing leasing to conventional financing, make sure that you know all the costs. Additional costs to look for when leasing are sales tax, and fees for documentation, lease origination and equipment disposal. Ask the leasing company for a copy of the lease agreement in advance and read it carefully. Make a dollar-to-dollar comparison.

Also beware of "fair market value" leases. With these, the option to purchase the equipment is based on the current value of the equipment at the end of the lease term, regardless of how much you have paid down the principal, commonly called "amortization." The fair market value of equipment at a lease's end is very subjective. Look for leases with a predetermined purchase amount, either as a percentage of the original cost or an actual dollar figure.

Matching the lease term to the useful life of the equipment is very important. Some contractors make the mistake of stretching the lease term out in an effort to make the payment smaller and more manageable. The longer the lease term, the more interest you pay. It's the same analogy you would use when deciding between a 15- or 30-year home mortgage. While the 15-year mortgage has a higher monthly payment, you'll save thousands in interest charges. The same is true with a lease.

If you choose to finance your purchase, regardless of the dollar amount, two things are usually required: a good credit history and a clear and organized presentation to the people who will be approving your loan.

Making a concise presentation is a very important part of the financing process that many company owners and senior executives often overlook. Managers look at dozens or even hundreds of credit requests a week and generally focus their time on those requests that are easiest to understand. A little time spent with a financial expert will often get you what you want with less time and effort. Paying a few dollars for good advice can help avoid a lot of time and frustration. The time spent putting together financial information and answering questions from financing sources is time away from soliciting new customers and managing jobs. It makes sense to go through this process as efficiently as possible.

(Brent LeVee is president of Chicago-based JEB Leasing Co., which offers financing options for vehicles and machinery for contractors. Contact him at www.jebleasing.com. Douglas Warren is president of Mainsail Finance Group LLC, a Lake Bluff, Ill.-based business consulting company. Contact him at www.mainsailfinancial.com.)