7 questions to ask yourself before investing in equipment or real estate.
Encouraging signs in the economy might have you thinking about investing in your business. Is now the time to purchase that large piece of equipment? Have you been considering a real estate expansion?
Planning to finance a major capital investment may seem like a burden to business owners, but with a little research and a quick self-assessment, the process can be simple. Ask yourself these questions as you prepare to meet with your banker:
How Much Can You Afford?
A calculation all lenders use is your Debt Service Coverage Ratio (DSCR). Take your cash that’s available (your net income after taxes, plus interest and depreciation expense) and divide it by your annual debt service—how much you pay in total loan payments in a year. Lenders tend to like that ratio to be 1.15 or higher, depending on collateral and the amortization period.
To increase your DSCR, you may want to ask for a longer amortization on the loan to help ease cash flow. You can always make additional principal payments if cash flow permits. Just be sure to inquire about prepayment penalties.
Can You Make a Larger Down Payment?
If you are able, consider making a larger down payment or put more “cash into the project.” It will result in lower monthly payments, and you’ll pay less interest overall. You also may be in a position to ask for a lower rate or longer amortization from your lender if you put more money down.
How Soon Will You See Your Return on Investment?
How long will it take to recoup your investment? Depending on the type of investment, that period varies.
For equipment, a normal payback period might be three to five years, allowing additional years of usefulness, though technology equipment may be less.
You also need to take labor costs and productivity into account. If expanding on the real estate front, how much additional labor will you need versus how much extra revenue can you produce in a larger space?
What’s on the Horizon for Your Industry?
We’ve seen industries like oil and gas slow down over the past year, yet others are booming. Obviously, your capital investment will meet the immediate needs of your company, but will you need an even bigger space in three years? Are there external factors in your industry that will impact your investment? Being well-versed in your industry and focusing on the trends and benchmarks over the next three to five years is vital.
What Is Your Competition Doing?
Are you ahead of the curve with your expansion? What sets you apart from them?
How Are Your Sales?
Trending up, right? Are you managing expenses so that net profits reflect that growth? Is the growth sustainable or due to a lucrative short-term contract? How will this new piece of equipment or larger production space affect income and expenses?
Will the Effects of the Investment Be Immediate?
Cash flow may be impacted as you wait for your investment to increase production. An interest-only period could help ease initial cash flow issues.
Other Options to Consider
Leasing // By leasing, you can obtain newer technology equipment faster, there are tax benefits, and you don’t have to pay for repairs or maintenance. However, you don’t own the equipment. You don’t show the asset on your balance sheet, you don’t have the option to sell the equipment, and sometimes you end up paying more than you would have with a purchase.
SBA Financing // SBA loans—for real estate or equipment—allow you to put less money down and perhaps amortize longer than a conventional loan. Businesses work with a bank, and the SBA provides a guarantee to the bank. Locate an SBA-preferred lender at www.sba.gov.
Equity Financing // This equity could come from friends and family, but also venture capital companies. This type of financing provides capital in exchange for a share of ownership in your company.
Your lender should and will ask a lot of questions. Being prepared to answer those questions will make your capital investment a reality faster.