Question: We have a lot of equipment and a lot of loans to go with it. We are always stretching to buy more. The upfront payments are killing me. How do we get ahead?
Thoughts of the day: Getting control over equipment costs can be challenging. You need to know what your equipment is worth to you. Build a strategy to maximize value and increase income. Manage cash flow by understanding the real cash cycles of your business. Plan your way out of debt with a multiyear strategy.
It”™s often hard to know what equipment costs or which pieces are the most productive. Your profit and loss statement gives an incomplete picture. Getting answers will take a bit of work but will yield insight and help you make better decisions going forward.
Start with a list of all of your pieces of equipment. Note what each piece costs: purchase including principal and interest; lifetime maintenance, repair and operating costs; lifetime labor. Not sure? Take a guess. Add up the total.
Estimate income earned per piece over its life. Again, if you have to, guess. Use an all-in number including labor income, since you built labor into your cost side.
Calculate the payoff ratio, which helps you get closer to the real value of each item on your equipment list. Divide the lifetime income of each item by its total cost ”” purchase, operating and labor. This is a rough estimate of an equipment payoff ratio. The higher the ratio, the better.
Go down through your equipment list. Circle the winners (top 10 percent to 20 percent) in each column: lowest cost, highest income and highest payoff ratio. Pieces of equipment that have two or three circled (cost, income, payoff) are home runs.
Think hard about equipment that has a low payoff ratio. It may be time to increase prices, replace inefficient equipment or change how equipment gets used. Boost the payoff ratio on every piece of equipment that you can.
Focus on high payoff equipment with the highest income. Strategize how to increase sales of these pieces. Find out why customers buy this type of service. Look for examples of who else might want to buy. Make sure you have enough of the right equipment in good repair to meet customer demand.
Sometimes a piece of equipment may be in high demand for a short period of time and then sit around the rest of the year. That can be a waste of resources. Line up places you can rent from without making a major commitment, or look for more steady income producers.
Buy equipment at the right time of the year. Owners often buy equipment when they feel flush with cash. That”™s also about the time that the slow season starts, just when they need to be hanging onto cash.
Make purchases right before the slow season starts. Cash on hand can decrease after a slow period. If down payments seem unaffordable, consider leasing rather than purchasing. Avoid big down payments. Make sure to select financing terms that are shorter than the usual life of the equipment.
Set revenue goals for the next three to five years. Break that down by types of work and types of clients. Which categories are likely to need additional equipment or tools that aren”™t currently in the business? What equipment will need to be retired or replaced?
Match an equipment buying plan to your revenue plan. Make sure you”™re buying the right types of equipment. Keep the current assets to current liabilities ratio over 2.5, and the current debt to equity ratio to under 4. Compare annual financing cost, including principal, to projected revenue and expenses to ensure a profit after paying off each year”™s loans. Hold off meeting with sales representatives until you”™re absolutely sure what you need and can afford. Keep bets low on new untested equipment until you”™re sure customers want and will pay for it.
Looking for a good book? “Lease or Buy? Principles for Sound Decision Making” by James S. Schallheim.
Andi Gray is president of Strategy Leaders Inc., strategyleaders.com, a business-consulting firm that specializes in helping entrepreneurial firms grow. She can be reached by phone at 877-238-3535. Do you have a question for Andi? Send it via email to AskAndi@strategyleaders. Visit AskAndi.com for an entire library of Ask Andi articles.
