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Cash Flow: Material Handling Financing Strategies

April 1, 2006
Buyers have choices to make when financing material handling equipment purchases.

In an old Jack Benny routine, an armed robber confronts Jack (known for his tightwad tendencies) and challenges: "Your money or your life!" Jack remains silent. "Well?" persists the anxious robber. "Just a minute. I'm thinking!" responds Jack.

While it is probably not the best idea to pause and consider the options in such a situation, it certainly is a good idea to pause and consider the options when acquiring new material handling equipment. Does it make more sense to buy outright? Rent? Lease? If leasing is preferred, what type of lease makes the most sense? Should the equipment be financed through the manufacturer? Or through a third-party? Questions, questions, questions.

"When customers are looking at a new DC or improvements to an existing DC, they are typically looking at large ticket investments with long-term expected use, between 10 and 20 years," says Dan Nasato, system sales manager for FKI Logistex (Cincinnati). FKI manufactures and engineers automated material handling systems, palletizers, and conveyors. "If a customer chooses not to include the cost in their next year's budget, then we look at creative or alternative financing, primarily leases."

One benefit of leasing, according to Nasato, is off-balance sheet liability, which provides flexibility for making other purchases. Another benefit is that it is usually easier to get funding for a lease. "If a company is going to purchase something, they have to jump through more hoops to borrow the money and have to open their books a lot more," he says.

A downside of leasing is that, if a company purchases material handling equipment, they can depreciate it over the years on taxes. "However, some people are not aware that the leasing of capital equipment can be written off as an operating expense," says Nasato.

Buy? Rent? Lease?
Tina McCaughey, director of financial services for Yale Material Handling (Greenville. N.C.), explains some of the pros and cons of buying, renting, and leasing. Yale manufactures and sells lift trucks. "We offer a lease vs. buy scenario for our customers," she says. Yale has found that customers who end up purchasing equipment outright tend to be those that may only need one or two trucks. They also don't utilize the trucks a lot of hours per year (usually under 500 hours). "As such, the trucks will last many years," she says.

If a customer is not sure where his business is going in the coming years (expanding, contracting, or staying the same), renting may make sense. "We are working with a customer now who is not sure if they are going to expand their fleet or reduce the number of trucks they have," she says. "In this situation, it may make sense for them to rent trucks on a month-to-month basis until they have a better idea of what will happen with their business."

Other than scenarios such as these, the most common approach to financing material handling equipment is to lease.

The In's and Out's of Leasing
Ken Ruehrdanz, business development manager for Dematic (Grand Rapids, Mich.), delineates some of the benefits of leasing. Dematic manufactures various material handling equipment, including cranes, conveyor systems, and AGVs. "By leasing, a user of a material handling system is able to focus on a manageable monthly payment instead of one large total payment," he says. "Most businesses operate with tight budget constraints, and monthly payments provide payment terms over time for a material handling system."

Dematic has found that, with a lease, a user will immediately see the cost savings and efficiencies generated by the new system solution, which in most cases will exceed the monthly lease payments. "In addition, leasing makes it easier to acquire a material handling system," he says. "That is, system implementation is not delayed while the user is seeking capital funding approval."

There are several types of leases. The two most popular for material handling equipment are operating leases and capital leases.

Operating Leases. The most common form of financing that Yale offers is an operating lease. "For most customers, we offer a 'true lease' or 'tax lease,' which is really a usage agreement," McCaughey says. This allows customers to use the equipment for a certain time period, then return it to Yale.

The company can customize this type of lease based on a customer's need. One of Yale's most popular options is its "Freedom Advantage Lease." This allows the customer to lease for a certain period of time, such as 36 months. Then, at the end of 36 months, the customer has three options. One is to turn the equipment back in. The second is to purchase it at the fair market value. The third is to extend the lease for an additional time period. "If they extend lease for another 12 months, for example, they can then turn it back in at that time and lease another piece of equipment," she says.

This type of lease is particularly popular with third-party logistics companies, which have contracts with customers for a specified period of time. "Let's say it's a two-year contract," says McCaughey. "At the end of those two years, they may not know if the customer will 're-up' with them or not." If the logistics company's customer does not re-up, the logistics company can turn the equipment back in to Yale. "If the customer does re-up for two years, though, we can lease-extend the equipment for another two years at a dramatically reduced rate," she says.

There are two important criteria that can help a business decide if an operating lease is more advantageous than a capital lease (discussed below). One is the size of the customer's business. "Larger corporations often prefer operating leases," states McCaughey. "They want to focus on their core business, and they are not in the lift truck business. They want a usage agreement for a specified amount of time, which is usually the economic life of the truck."

The other consideration is the customer's financial situation. An operating lease provides off-balance sheet financing. "Customers don't have to list the units as assets or liabilities on their balance sheets," she says. Many companies don't want such equipment on their balance sheets because of covenants they have with their banks, which dictate that they can't go over certain financial ratio restrictions. "This would affect the credit lines they have with their banks," she says. "The monthly expense they pay for the lease shows up as an expense on their income statement, which reduces their taxable income, which reduces their tax obligation." As such, a lot of larger customers use this expense to reduce their tax liability.

Capital Leases. A capital lease implies ownership intent. "This is more of a finance agreement, similar to a mortgage on a home," says Yale's McCaughey. "It has an ownership intent, in that the customer would own the equipment at the end of the lease and would not be returning it to us." The most popular type of capital lease for Yale is a "full pay-out (FPO) dollar option lease."

As with operating leases, capital leases may make more sense to some businesses based on their size and their financial situation. "One-and two-truck users tend to go for capital leases, especially the FPO dollar option lease, because they want to own the equipment," says McCaughey. "If the company is the owner and is listing the equipment as assets on their balance sheet, they can depreciate it on taxes," she says.

Financial Analysis
HK Systems (New Berlin, Wis.), which manufactures automated material handling solutions, including automated storage and conveyor systems, arranges to have its customers meet with a specialty finance company, GE Commercial Finance Capital Solutions (Irving, Tex.), to discuss options.

"The first thing we ask a customer is if they are interested in hearing about what the savings could be on financing options," says Jeff Hedges, director of business development for HK Systems. "When we work with customers, we interface with their logistics, engineering, and supply chain people." HK and GE also involve the customer's finance people, including the CFO.

"These are the people who under-stand the true value of a lease," says Hedges. "People without a finance background may not really understand the intricacies and the real value of a lease, as opposed to purchasing something outright."

"CFOs are interested in the net present value of the whole solution," says David Pastre, v.p. specialty finance, for GE Commercial Finance Capital Solutions. "They want to know the investment return they will be getting on the project." If a customer doesn't want to come up with capital dollars today, the participants study what the overall return will look like after financing.

"We then ask the customer if they have any other requirements outside of deferring capital expenses," says Pastre. "For example, they may want to look at technology obsolescence risk. They may also be interested in looking at something other than a straight loan or capital lease.

HK Systems offers customers a "re-turn analysis" on their projects. "We have added financing information to that model," says Pastre. "This allows customers to determine things such as: If the internal rate of return is X, and if we finance it through one of several different options of leasing, what kind of enhancement would we get for our return?"

While there are circumstances when renting material handling equipment or purchasing it outright may make sense, most companies prefer leasing. Of the two most common, operating lease and capital lease, the former is the more popular, except in situations where the equipment cannot be returned (such as permanently installed equipment). Before making any decision, it is important to conduct a thorough cost analysis on all of the various options.

Bill Atkinson is a freelance business journalist with more than 29 years of experience writing about the supply chain, workplace safety and other topics.

Tired of Private Financing? Ask Uncle Sam for Help!

Years ago, according to Derek Cribley, systems manager for Bastian Material Handling (BMH, Indianapolis), few customers asked about financing options. BMH sells Hytrol Conveyor systems. "Most of our customers arranged financing on their own," he says.

In the last couple of years, though, the question has become more common. To this end, BMH established relationships with third-party leasing companies to which they could direct their customers who sought lease financing. "These arrangements are similar to those that involve customers leasing the buildings where they operate their businesses," he says.

Even more recently, BMH has been noticing more state and local government programs that provide capital equipment leasing options. In the past, according to Cribley, state and local governments often provided tax abatements and other incentives. One incentive might be for the government entity to purchase the building, then lease it back to the business. These days some of these government entities are taking this concept a step further, purchasing the building and the capital equipment inside the building, then leasing everything to the business!

"One of our customers that is building a new facility, in fact, has been reading about this and is arranging for a government agency to make the capital purchase of their material handling equipment," says Cribley.