When To Purchase Assets & What to Ask
Asset acquisition is a necessary step in growing your business, but it can be costly and a mistake if done incorrectly. We are not writing this blog to scare anyone into not purchasing assets since one thing that Waterford Business Solutions loves to do is help its clients recognize, grow, and achieve their financial goals.
Those financial goals, whether your business goals are to increase your labor force or your revenues, all have essential routes to succeed. Asset acquisition goes hand in hand with business growth in our specialized industry: HVAC, contractors, electricians, and plumbing.
Planning it Out
Planning is the first step in asset acquisition, whether the asset is significant, like a vehicle, or minor, like tools. The cost calculation should not just include the vehicle cost for a purchase such as a vehicle. $3,000 to wrap the car, $10,000 to add the ladder racks, and adding other equipment paid takes a sticker price for a $60,000 truck to a total cost of $80,000.
Besides planning the cost, the business should have a technician ready to drive it, tools prepared to outfit it, and a marketing strategy to ensure the extra work for that van. Besides using a van as an example, let’s use an example of heavy equipment. Vans are more of a necessity for businesses, whereas outright owning heavy equipment has other options.
No Stone Left Unturned
A business should ask itself many questions before purchasing heavy equipment. Are there enough jobs that use the booked equipment that renting is not cost-effective? Again, looking at the sticker price of the equipment vs. rental vs. contractor. The business should budget for maintenance, storage if there is no on-site space, and someone who can operate the equipment.
There are a lot of factors to consider leading up to the decision to purchase. First, we need to see if the asset will pay for itself. It should also bring in enough revenue to justify the purchase. If it does not make sense, the business should avoid taking on the asset.
There is a common misconception when it comes to buying assets. We often see those doing their books put loan payments for a vehicle on the Profit & Loss statement. However, if you are financing a truck, the only portion expensed out is interest; the rest is recognized when you depreciate the asset at the end of each year. Depreciation expensing is also true for any cash-paid assets.
The expense will be recognized as depreciation, not at the time of purchase. Because of this rule, Waterford recommends only creating asset items with multiple years of use or a value of more than $1000.
Financing vs. Outright Purchase
If purchasing does make sense, there are even more factors to consider after deciding to buy. When deciding whether to finance or to purchase outright, the business should look at their cash flow and how much either would affect their everyday business operations.
If you do have excess cash, purchasing outright means interest would not need to be calculated into the cost to your business to acquire that asset; however, it is not wise to deplete your cash flow as it could cause more significant issues for the company not being able to pay your employees is a much bigger problem than not having another vehicle.
There are a lot more questions when it comes to financing than outright purchasing. To begin with, the questions that need to be asked include: where will you get the funding from? You have multiple options: there are banks, credit unions, and many vehicle dealerships that have their internal financing.
Ensuring you can cover the three to five years of payments in your cash flow is essential. If you can’t do that, outlaying the entire purchase price is probably not the best idea.
There are very few companies that are still giving out zero-interest auto loan. If you are lucky enough to get that, definitely jump on it; however, when you’re looking at this total cost, you’ve got to consider the amount of interest we currently see, about 6%. If you look at the math for a $60,000 truck, you would have to pay $3600 in interest.
The most crucial part for a business to think about when it comes to financing is that they don’t just jump into financing a vehicle. The factors that need to be examined are ensuring that the interest rate makes sense for your business. We have seen up to 28% interest rates on trucks people wanted but didn’t necessarily need for their business.
When you break that down, the company needs to be able to cover that cash flow, as it won’t show up on the profit and loss. Many companies only look at their financial health based on profit and loss; however, if multiple loans go through the business, a lot of cash flow is put toward those assets.
Once the business has decided that purchasing a vehicle or other asset is the route they’re going to go, you have to calculate that the car or the asset will not be in use by the following day. For example, suppose you go out and buy a new truck because you have a new tech and an expanding segment for commercial service.
In that case, the first step is you’re going to get that vehicle, but you’re going to need to wrap it so it’s advertised and ready to go, which will probably take a week. You also need to look into what tools, racks, and storage tech will need to do this job successfully and efficiently. Ultimately, the business will pay one of those monthly payments before you start generating revenue with that asset.
Even if we’re looking at the example of equipment that says you need a new forklift, you have to make sure that the texts that will be using it have the experience, are comfortable, and are licensed for that particular equipment. Smaller assets like tools and office equipment will be more ready the next day than these more significant assets.
Overall, this blog ensures you look at all asset purchasing sides so you can pick and choose which assets are necessary for your business. Making sure the business is doing their due diligence before jumping into those decisions includes asking these questions:
Is the business ready to take on this cash flow burden?
Do we have the work that makes sense to purchase this asset?
How can we afford this asset in the long term scenario?
Do we finance the asset and what will the interest rate be?
Do we pay out of pocket and how does that affect cash flow?
It does depend on your specific business. We can’t touch on every scenario related to purchasing assets; however, this blog is a good start when making those decisions. However, the biggest disadvantage of an asset purchase is the affect on CASH FLOW.
If you ever need assistance reviewing your business using some budgeting software to review how your cash flow will be affected by these purchases or just discussing the best options for your business, please don’t hesitate to contact Waterford Business Solutions. We know the industry. We have the accounting experience to have seen the effects of planning for and not planning for asset purchases.
Check out our youtube video When to Purchase Assets and How to Plan for the Acquisition with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.
