Equipment loans are so valuable for growing businesses. But you do need to think about whether it makes sense to get a business loan before signing. This blog post will outline some of the major factors you should consider before taking on an equipment loan.
6 Key Things to Think About Before Taking on an Equipment Loan.
- Why are you getting this loan – and will it help your business grow?
- What type of loan or equipment finance suits your purpose/needs?
- How much do you need to borrow?
- Can you afford the repayments? (Ideally you should have a 12-24 month cash flow projection completed when considering this question.)
- Do you understand all the key terms and conditions (like exit fees, fixed/variable interest)?
- Do you have adequate security?
Once you have answers to these questions, you’re in a position to weigh the risks and rewards of getting an equipment loan and make an informed decision. If you have any trouble answering these questions, you might benefit from professional help.
A Deeper Look at an Equipment Loan
Let’s consider this situation:
A five-year-old medium-sized bicycle store needs a spoke cutter and a forklift. After a really strong year in 2020 – and with the bicycle industry forecasted to continue to grow for the next three years, the business can see the long term benefits of upgrading their equipment to help them continue to grow. They are considering an equipment loan from a bank.
Equipment loans allow businesses to purchase (and own) equipment, with the lender taking a mortgage on it as security for the loan. The loans typically range in duration from two to five years, depending on the type of equipment being purchased, and they may have a balloon payment at the end.
The Pros and Cons for an Equipment Loan Include:
Tax Considerations and Advantages
Depending on the structure of the debt, you may be able to claim input tax credits for the GST included in the purchase price. Additionally, you will likely be able to claim depreciation on the equipment and make a deduction for the interest component of your loan repayments. Getting the loan structure right is crucial to these advantages though. There are important differences between Chattel Mortgages, Leases and Business Equipment Loans.
Balloon Payment Structure
Equipment loans may include a balloon payment at the end. These loans have a lower monthly payment, but you must repay the outstanding amount in one payment at the end of your loan term. You will pay more interest over the course of this loan.
For some businesses, this payment structure will be an advantage. It allows you to keep more money in your pocket at the end of each month until the loan term ends. But you will need to plan for the balloon payment at the end.
For other businesses, equipment loans with a consistent payment schedule and lower overall cost of borrowing are preferable. This structure provides greater certainty for companies with cash flow fluctuations.
The bicycle store decides to proceed with the equipment loan with a balloon payment at the end of the term. The equipment will help them grow, by allowing them to offer a service that they currently outsource. As a new business, they would benefit from keeping money in their pockets – and using it to expand more while demand is booming. The store is certain the balloon payment at the end of the term won’t pose any problems. Now is the right time.
Sharp Accounting Can Help Determine Whether Your Business Should Take On More Debt
An advantage for one business might be a disadvantage for yours. You should seek advice if you’re uncertain about how your financing will affect your business.
Sharp Accounting believes that a great accountant should be across the day-to-day operations of your business, casting a critical eye over the business to provide insight and advice about how your business is traveling. In fact, your accountant should regularly be working with you, to not only improve things now, but into the future.
We’d be happy to have a free chat with you about your business, business loans, and how we can help.