New Equipment?

Payment Options for your Business
By:
Andrew Nere
Innovative Lease Services, Inc.

Whether you are opening a new salon, expanding an existing salon, or opening an additional location, the method you choose to acquire your equipment can have a profound impact on your business, your credit, and your cash-flow.

The most common methods salon owners use to purchase their equipment are paying with cash, charging with a credit card, getting a bank loan, and leasing the equipment.

Paying Cash

Paying cash is universally mistaken as the least expensive choice. The cash in your bank account has already been earned and represents what is left over after taxes have been paid on that income. So the conventional wisdom that paying cash saves on any interest expense is actually quite an expensive mistake given that you’re using after-tax dollars. Additionally, using cash for revenue producing equipment can be a capital budgeting mistake and here’s how:

Cash is already expensive. If you paid 35% in taxes last year and you saved $40,000 in the bank, that cash on hand actually represents $61,538 in earned revenue.

“Cash is King”

Cash is also the most valuable commodity your business possesses and should be used to the best strategic advantage. In short, you should use your cash to drive more cash (through sales) into the company. Restrict your cash expenditures to drive revenue and use your cash for marketing, advertising, and promotion.

You don’t purchase all the gasoline you will use for the next five years when you acquire a new car. Instead you purchase your gasoline as you use it. This simple analogy translates well into equipment purchases. Quite simply, pay for your equipment as it makes you money; match the revenue to the expense.

It is commonly accepted within the financial community that the most prevalent reasons for business failure are insufficient capitalization and poor cash flow. If we accept this as true then paying cash may have an adverse effect on your business’s ability to succeed.

So if we can accept the premise that financing is a more effective capital budgeting solution for your salon than paying cash, then lets explore the most common financing alternatives; credit cards, bank loans, and equipment leases.

Credit Cards

Credit card issuers have spent hundreds of millions of dollars convincing American consumers that their “Promotional APR’s” are a sound budgeting choice. The reality is that a credit card is a fantastic short-term tool. As a revolving account the credit card should be used only for short-term needs (30 days or less) and ideally your credit card balance should be paid down to $0 every month.

Using your credit card for equipment acquisition is a poor choice overall for the following three reasons:
• The credit card amortization period is much longer than the life of the equipment being purchased in most cases (you’re paying for it long after it is worthless).
• The rate on the card is subject to change at any time with rising interest rates or changes to your credit score (did you know most credit card agreements can increase your rate if you’re late on any of your accounts, not just theirs).
• Credit card debt is reported on the personal credit bureau report as “revolving debt.” Increases in total revolving debt and the subsequent decrease in the “revolving percent available” typically lowers your overall credit score.

Bank Loans

Bank loans traditionally offer the lowest stated APR% (please see below for a discussion about effective APR on these loans). Bank loans may also seem convenient by simply applying for a loan at the same place you bank. For these two reasons many businesses still look to the bank as the sole means for financing. Indeed, your bank is a fantastic place to look for building or land financing with extended terms out to 30 years. However, on shorter term or for equipment financing, the bank is not a great option, here’s why:

Effective APR%

The reality about bank financing for equipment acquisitions is quite different. Bank loans can often be dramatically more expensive when the large security deposit required is factored in. The reality is that the stated APR% and the effective APR% are usually dramatically different

This hidden profit for the bank is due to the down payment. Typically a bank will want 20%-40% as a down payment for salon equipment. For instance, a stated 8% bank rate with a 25% down payment is really equal to a 21% effective APR on a five-year loan.

Bank financing is also elusive due to the fact that banks are very conservative when it comes to loans. An ex-banker we work with has quoted the statistic that only one in three loan applications are approved by a typical bank. Banks also tend to take weeks to make a decision, Salon owners usually need to move quickly on their equipment purchases so that they can focus on increasing their sales.

Equipment Leasing

Leasing your equipment has several advantages; 100% financing, tax benefits, ease of approval, Commercial debt not personal, and cash flow benefits.

Typically an equipment lease allows for 100% financing (including all installation, delivery, and applicable tax). Many different types of equipment from different suppliers can be combined on your lease agreement. Be sure to work with a leasing company that will help you coordinate with all of the suppliers; this can really free up your time and relieve you from this burden.

Your equipment lease is structured as a “rental” payment for a fixed term at a fixed monthly payment. Once the term is paid, there is typically a nominal option to purchase ($1.00, 10% of the original cost, or fair market value), conveying ownership to the customer.

Because of this “rental agreement” structure, many customers will elect to expense the entire amount of the monthly payment (always check with your own tax adviser regarding tax planning). By expensing the entire amount of the payment, you have a direct tax benefit every year.

For instance, if you are in a 35% tax bracket and your monthly payment is $1,000, your tax benefit is $350. Your effective payment, then, after tax benefit is $650. When this payment amount is converted to an APR%, the “effective” rate is often less than 5%, sometimes even negative.

Your lease application is typically only one page. For established businesses (over two years in business), this application can qualify you up to $75k. For new businesses, additional credit information is typically required (call the leasing company for specific details).

Most leases will require that any owner of the business greater than 10% is required to personally guarantee the lease. However, most leases (check with your leasing company) will not report on your personal credit report as long as the lease is paid as agreed. Equipment leases are typically commercial contracts and thus help you build the strength of the business. This benefits you by adding a credit source for your business, not another personal trade line.

Basically, you’re paying for your equipment as it earns you money. This follows the basic accounting principal of “matching” where you tie your expense to the revenue it produces. Additionally, you make your payments in cheaper dollars every month due to inflation (on a five year lease at 2% annual inflation your payment at the end is in dollars worth 90.4 cents compared to $1 today).

The biggest downside to an equipment lease is two-fold. First, because the equipment lease is legally a rental contract, there is no benefit for paying off the lease early. Typically your payoff at any time in the lease will be the remaining payments due under the contract. Secondly, the lease approval decision is usually made based in large part on the personal credit history of the business owners. Check with your leasing company but typically FICO scores less than 580 will not qualify without additional guarantors.

Whatever alternative you choose make sure that your decision is based on an analysis of both your current and future needs. Most importantly, don’t forget one of the most important reasons you got into business for yourself in the first place, to make money.

When structured properly, effective use of “OPM” (Other Peoples Money) when acquiring new equipment can allow you to grow your business, increase your profits, and save on taxes.

Andrew Nere - Innovative Lease Services, Inc. (ILS) in San Diego, CA. specializes in Salon Equipment Leasing.

For more information go to www.SalonLeasing.com or call their Salon Division at (800)438-1470.