Borrowing for Equipment Purchase — Good or Bad?
A revolving line of credit to ease cash flow at times is a good thing to have. But that is short term. I am a firm believer that you should use your own money if you have it. Invest in yourself. You shouldn’t pay interest just to have a tax deduction.
From the original questioner:
I agree that using your own money first is the way to go. But if one does not have idle cash on hand does that make the new tool purchase with borrowed money a bad investment - even if it will increase production enough to more than pay for itself and interest? I remember a story the father of one of my former employees told me. He is a farmer and was at an auction. He could not believe how cheap a couple of wagons sold for. "Sure could have used them wagons" he said. "Why didn't you buy them?" I asked. "Because I didn't have the cash and wasn't going to borrow it" he replied. My guess is he paid for those wagons many times over in extra running around and grain degrade.
From contributor A:
Sometimes people mistakenly compare the increase in production a tool has with the ability of it to pay for itself. There was a reason those wagons were being sold at auction in the first place. Maybe the farmer’s overhead was too high? Being able to do a job faster makes you money on that job. But it also now creates an opening in your production time that needs to be filled with more work. Being able to fill that opening is what matters.
From the original questioner:
Actually the farmer who sold the wagons lived not too far from me. He sold out and retired a successful man.
From contributor B:
It's called leverage. And like any lever, it works for you or against you, and interest rates are higher when borrowing than lending. It's part of the risk-reward equation. If one borrows money and leverages it to make more money, then they are successful. If they borrow more than they can put to use, cannot manage it or the resulting business, then the leverage is against them. I think we all have seen people in one business or another who couldn't manage this and it got them. Many of us in this business are conservative financially and don't want to risk the lever working against us. Two pieces of advice I received that I think are useful are: Don't grow too fast; and debt is not all bad if you have something to show for it.
From contributor C:
I would have to agree with contributor A. What would you have to borrow money for? I started my shop with $5,000. $2,000 went towards the lease of my shop then the other 3 went to tools. I replaced that within a few short weeks. Then I bought KCDw and paid it off. Then I got a bunch more used tools for $1,000. For $12,000 I had everything, but bought it at a pace where the customers were paying for it with work that I was doing. I have everything I need to build just about anything and the stuff I don't have, I will. And I will have never had a loan. Would this loan serve the purpose of expanding, getting new machines and more guys? So you are not just getting the loan you have to pay for, but you are getting more guys to pay for, more shop space to pay for, more tools to pay for. The more money that you owe, the more jobs it takes to pay it off. The more jobs you take, the more guys you need, the more guys you need and jobs you take leads to the need for more space. If you can acquire all that and pay off the debt go for it, but I think the loan may become a burden. Frankly I've been scared to do much of anything but stay small. I'm like a snail that is too scared or stupid to look for a larger shell when it grows. At least I'll be debt free.
From contributor D:
The risks of borrowed money are greatly magnified for those of us with small businesses. As I have gathered from the posts over the last year or so, most of us run small shops. Being self employed, we never know what tomorrow will bring - fat job, big profits, or a customer who stiffs us, or maybe an accident that leaves us unable to work. But the bills and loans remain. I started my business in 1967 at the age of 17. It is the only job I have ever had, less a few years as a naval officer - mainly to work off my schooling and keep my butt out of the Army. In 1978, while the loan industry was in one of those "truth in lending" frames of mind, I was buying my first house. When I asked the loan officer what I really had to pay back, I made my mind up right then I would never borrow again. Over the years I paid cash for my autos, trucks, boats and toys, as well as what ended up almost half a million in business equipment. My motto was don't buy unless you can pay cash, and pay for it only once! A car on a 3 year loan costs you twice the sticker price. At times my kids got upset at me. My friend bought a boat - a nice 20 footer for 180 easy payments. I now have a new 40 footer. He paid more for the 20 footer including interest than I did for the 40. And you can imagine what that 20 footer looks like now as that last easy payment was made. Go slow and pay cash. You'll sleep a lot better at night and worry less on the job. I am now 55, with 38 years in business. I am retiring next month and would do it all over again the same way.
From contributor E:
Borrow $ 100,000.00 and buy woodworking equipment and 5 years later it will be worth $50,000.00 or less, so how much money did the machine make you ? Borrow $100,000.00 and buy a shop and 5 years later, what will it will be worth? My point is, what is the money being used for and who is doing the guessing?
From contributor F:
I see borrowing money, when analyzed correctly, is smart. Would you rent a house until you saved enough to pay cash? The most expensive part of being a business owner, in this field, is labor. Finding good quality labor is also the most difficult task for an owner.
I can pay someone to work for me on a weekly easy payment plan, plus pay for their overhead (taxes, vacation, etc.). Or, I can often pay for equipment that will offset that labor cost (CNC, wide-belt sander, etc.).
One guy costs me about $4000/month. If I can offset the cost of that labor by borrowing money for a machine, it makes total sense. I can then use my talented guys to do the work machines can't do. I think a lot of this depends on your size and future plans. You need to analyze what you are purchasing, and make a decision based on a cost/benefit analysis. If the machine doesn't pay for itself, it's not a smart decision to borrow money. I think many of us in the business are also tool freaks. We have to be cautious of buying the latest and greatest for that reason. But, to say to “never borrow" is not good advice. I borrowed money to buy my building. If I had waited to pay cash, where would I be? I would be renting from someone else. The same goes for my equipment. I could pay for the labor, or pay for the equipment on a lease or loan. It depends on what makes the company more profit.
If I wanted to be a one or two man shop, and never grow past that, the analysis of the equipment loan would be totally different. It's based on the production level, and how much the machine will save me in labor. The larger you get, the easier it is to justify borrowing for equipment. I plan on being in business for the rest of my life. So, I'm either going to pay for equipment on a loan or pay for the labor. Both will always be there.
From contributor G:
Baby steps - the easiest thing to do in business is to borrow large sums of money and to hire many employees. The hardest thing to do in business is to find enough work in a consistent time frame and at the right price to pay for the previous overhead. Overhead is consistent whereas work often is not. I think using a one year credit line previously suggested is the correct method. They say if a piece of machinery can't pay for itself in one year then you should not buy it.
From the original questioner:
To contributor F: I think you hit the nail on the head. I agree borrowing makes more sense with more employees. I am an 8 man shop. Borrowing is the single most important tool that allowed and still allows me to grow. Had I not borrowed I would still be stuck in a rut with one part timer and 1000 sq. ft. I suppose it depends on what a person is comfortable with. But if one has never borrowed for business how can they recommend against it? I also realize that what works for me may not work for the next guy.
From contributor H:
Personally, if I had $80K to spend on machines hoping to make more money, I wouldn't need to make more money - just find better investments. My opinion is that you should do your best with what you have. If you reach the point where you must grow or die, then decide if you want to spend your savings or borrow. Either way it's a risk because you don't know what tomorrow holds. And counting on tomorrow is a mistake, but that doesn't mean you shouldn't be prepared for the future, or live only for today. Think like a Boy Scout - always be prepared.
From contributor I:
I will preface everything I say here with the fact that I have been totally debt free personally (including my home) since 1994, and have been debt free personally on everything other than my home since 1987, so I obviously fall in the debt free camp on that side of the equation, but I have borrowed for equipment purchases for my business consistently for many years now. There has to be a distinction made between borrowing money for a big truck to make one look cool, and borrowing for a piece of equipment that can earn money for a long period of time.
Both the truck and the equipment could be classified as a depreciating asset, but the truck’s value is falling as fast as its serviceability, and although the machinery value is falling, if you were to try and sell it, its usefulness, or ability to earn you money is only depreciating by its ability to earn money in the future. For example, I have a Powermatic saw I purchased in 1990 for less than $2,000.00, and it is just as capable today of earning money as it was the day I purchased it, but I don’t own a single vehicle that I owned in 1990.
There is a difference in purchasing equipment as an investment in future income with debt, and purchasing a boat, motor home or airplane with debt. But we have to purchase equipment, software, etc. intelligently, based on actual sales and production data, not our desired results, or our emotional love of cool equipment. For every horror story of a cabinetmaker losing his business because of excessive overhead, there are at least several others who have made excellent livings for themselves and their families because they were willing to invest intelligently in their business profitability.
I believe that most of us are too quick to make a purchasing decision based on bogus production data that only considers local production increases, while ignoring our sales or production constraints. Every investment has to be looked at from the global production aspect. We have to ask ourselves this question - will this decision allow us to sell, design, engineer, purchase material for, manufacture, finish and install more products now and in the future? There must be a logical method of thinking through the implications of a negative answer to any one of those areas. I believe that the Theory of Constraints provides the thinking tools to assist one in the logical method of thinking through these decisions.
Another aspect of this topic is the fact that many times (almost always) we are paying the equivalent of the borrowed money plus interest in additional handling, inefficient processes, ineffective construction techniques, etc. In other words, we are paying for the really nice machine, software or product but can’t enjoy the benefit of owning it. The analogy that works for my 4th grade level of thinking is called minimal complexity. To kill a mouse, you have to have all of the parts of the mouse trap, and they all have to be in working order. If you have 4 out of 5 pieces, and all 4 of those pieces are in perfect working order, the fact still remains that in the absence of the 5 piece, you will not kill any mice.
A perfect manufacturing system with the best equipment and management systems, but without an equally effective marketing, sales, design and engineering equipment and system will ultimately fail; it is a simple matter of minimal complexity. Every single part of your eyeball has to be working for you to see, every single part of two completely independent sexual organs have to work for reproduction to take place. We have to have all the parts and pieces of our cabinet manufacturing businesses in near perfect working order to be profitable and effective, and we can’t ignore any of the dependant events when considering any investment. We must think globally - not locally - when we attempt to increase our production with people or machines.
One last comment - if done well, borrowing money to purchase machines to increase your profitability (don’t confuse growth of profitability with physical plant size, or employee growth, or growth for growth’s sake) can lead to the ability to borrow money against your own money - having your cake and eating too. When we borrow against our own money, we are not putting ourselves, our business or our family in jeopardy; we do have a certain way to pay. We get the benefits of a tax write off, and at the end of the loan cycle, we have the equipment, and the money to show for our effort.
From contributor J:
I think it's OK to borrow money as long as all the sums are done and the whole scheme is properly thought out. It's mostly to do with growing the business. There are virtually no large companies that do not exist on borrowed money. Every company that has issued shares is using borrowed money. My van is leased, a brand new Mercedes which looks smart, runs perfectly and I know almost exactly how much it's going to cost me each week, at a price I can easily afford. I thought about it carefully and did the calculations first. I will need some new machines soon. I don't have any spare cash so I either have to lease the machines or go without. I know what each hour in the shop costs me, and I know how much I want to make. The calculations are quite easy and I'll get the machines as soon as I need them.
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