In my last blog, The Wisdom of Perpetual Upgrades, I wrote about how the availability of capital often drives the timing of retrofit projects. In the interest of walking my talk, I would like to present one possible solution to the problem of capital availability driving project timing: leasing. To cover this topic appropriately, I spoke with Bill Summers, director and vice president of Vision Financial Group. He shared his insights to the world of leasing and why it may be a good solution for manufacturers when considering a retrofit project.
As Bill puts it, "The equipment leasing and finance industry happens to be built around making the necessary capital quickly available for automation projects and other capital intensive projects that require funding. These projects usually either don't have enough (or any) money earmarked within the company's budget or the budgeting office simply won't or can't progress with the same sense of urgency that the automation engineering team recognizes a need for."
The primary key in approaching the prospect of leasing, according to Bill, is "recognizing the need." In other words, the project in question must make good and justifiable business sense. This means that the automation team has done their homework and they know that the project in question will bring measurable operational efficiencies or increases in quality that justify the implementation of the project. Positive increases in cash flows, resulting from successful implementation of the automation project, might come from cost savings, increases in production efficiencies, and decreases in waste or rejects.
Relating his experience working with a non-destructive testing (NDT) services company, Bill shared how the company used leasing to invest in a customized automated ultrasonic testing (UT) system. This investment was important for the company, whose entire business is built on identifying and eliminating rejects for third parties. To take advantage of a business growth opportunity with an aerospace components manufacturing company, an investment in the UT system was clearly necessary.
"The business case to implement the UT system made perfect sense," Bill said. "However, the NDT services company did not have the funds available in the budget. When the opportunity was presented to the company's finance department internally, there was pushback from both the controller and the chief financial officer because the company was expanding in other areas and capital was scarce. Furthermore, the CFO did not want to take out a loan to pay for the UT system because the added debt would have negatively (and considerably) skewed the company's debt-to-worth ratio. The result, feared by the CFO, would have been an elevated cost of funds on the company's operating credit line with its bank or, worse yet, a violation of the company's bank covenants if certain business objectives (totally unrelated to the UT system project) were not met as planned. In other words, a fantastic business opportunity was going to be shelved because of capital concerns."
The solution came from the integrator of the UT system who presented an equipment leasing solution. According to Bill, the lease was structured in a way so that the lease payments were not considered debt obligations. In this particular case, the payment stream didn't kick in until the project was implemented and the NDT services company started generating revenues from the new UT system. This is called "matching the lease payments to the project's cash flows." Not only were the CFO's objections to implementing the project eliminated, but the engineering team that brought forth the project looked like heroes.
For those who aren't familiar with using leasing as a cost-effective procurement tool, it's important to note that when it comes to creatively financing projects. Most soft costs like installation and engineering can be included within a lease.
Going forward, if you've determined that a project that makes good business sense, but the capital isn't available within your organization, it is probably well worth your time to consider leasing as a viable source of capital.