No matter the size, industry or growth stage of your business, it needs equipment to operate. Having the right equipment can help you scale up your business or improve the way it functions by making processes faster, cheaper, or by reducing waste.
But purchasing or upgrading the equipment your business needs can be a big expense. Equipment financing allows you to buy the tools your business needs, without a major hit to your cash flow.
What is Equipment Financing?
As the name implies, equipment financing is a specialised type of business financing used to purchase equipment. What constitutes equipment varies by business, but can be thought of as anything physical that the business uses in its operations. This could include, for instance, computers, furniture, medical equipment, vehicles, construction equipment and other specialised tools and machinery.
With equipment financing, the equipment may itself be used as collateral. For new or small businesses that do not have other assets to secure the loan, this built-in collateral is a major advantage. Also, once the debt has been repaid, the business owns the equipment outright.
Equipment financing covers a significant percentage, and in some cases the entire cost of the equipment. Business owners who may not have much cash reserves can therefore avoid having to raise large sums of money upfront before they can buy the equipment they need. Even owners who already have the capital to buy may prefer to use equipment financing to free up funds to use elsewhere in the business.
Equipment Financing vs Equipment Leasing
Equipment financing should not be confused with equipment leasing. With equipment leasing, you make regular payments for the use of the equipment over a period of time. Unlike equipment financing, you do not own the equipment at the end of the lease term. Instead, you may choose to renew the lease or buy the equipment.
Leasing typically does not require a down payment the way some loans do, and might be easier to qualify for than equipment financing. However, equipment that is leased long term could end up costing more than if it was bought instead.
Leasing, therefore, might be a better option for acquiring temporary equipment or equipment that will become obsolete soon after being paid for. On the other hand, equipment financing is better used for equipment that is important for the long-term operation of your business. Here are some of the more common ways to approach equipment financing:
There are two main types of loans that can be used for equipment financing: equipment and term loans. Equipment loans use the equipment being purchased as collateral. While some lenders would require a down payment, it is possible to get 100 percent financing in some cases. It is often easier to qualify for an equipment loan than a traditional term loan, so this may be a better option for small or newer businesses.
While a term loan might be more difficult to get, more established businesses could take advantage of lower interest rates and higher credit limits. Term loans can be secured or unsecured. For loans that are secured, you may use the equipment as collateral or some other business asset.
Business Line of Credit
With a business line of credit, you can borrow up to a certain limit. You withdraw and repay as you wish — once you don’t exceed your limit— and only pay interest on the money that you borrowed. This differs from a traditional bank loan, which gives you a lump sum that you repay over a fixed period. Lines of credit typically do not require collateral, but carry higher interest rates, which can make your equipment more expensive over time.
Business Credit Card
Business credit cards work like credit lines, where you have access to a fixed amount of money that you can draw from. The credit limits on business credit cards are usually less than lines of credit, however, and cash advances on credit cards tend to be more expensive. Interest rates are often also quite high and many cards charge annual fees.
Despite these drawbacks, business credit cards can be useful to local businesses that import equipment from merchants who sell online or who prefer credit card purchases. Some cards also offer rewards, like cash back or travel miles.
What to Consider
Before you decide the type of equipment financing that is right for your business, there are several things you should consider.
The total cost of borrowing will include the interest rate along with any upfront or maintenance fees. It’s also important to note whether the interest rate being offered is fixed or variable. Variable interest rates fluctuate, meaning your expenses could increase as they go up any number of times during the repayment period.
The payment term affects the overall cost as well as your monthly cash flow. A shorter payment term means that you will own your equipment sooner, but your monthly payments may be higher. Whereas a longer term with smaller monthly payments would be easier on your cash flow, you may end up paying more interest overall once you have paid for your equipment. In general it makes sense to match your payment terms to the life of the equipment. That way you are not paying for equipment long after you have stopped using it.
You should consider how much of a down payment you may be required to pay for different financing options. If you can afford a bigger down payment upfront, you could decrease the size of your monthly payments. On the other hand, businesses without much cash on hand would benefit from having to come up with a smaller down payment.
Finally, you should understand the financing requirements of your lender, which may depend on your credit history, number of years in business and annual revenues.
Applying for Equipment Financing
When you apply for equipment financing, lenders will want to see that your business is profitable and capable of repaying your debt. Be prepared to show records of your business and financial history.
At DFL the most important documents we look at include:
- Business plan
- Three years of financial statements
- Cash flow projections for three years
- Valuations on equipment to be held as collateral