Sidebar What Does the Current Depreciation Bonus Mean to You?

To determine the optimum mix of owned, leased, and rented equipment, look first at equipment utilization. What contracts are you winning? How long will you use a piece of equipment? How quickly can you experience a return on investment? And, importantly, how far ahead can you accurately forecast business parameters? In today's uncertain climate, that's not always an easy task. For example, consider that the short-term extension (rather than a full six-year reauthorization) of the Transportation Equity Act for the 21st Century might cause some states to delay lettings. So contractors remain cautious.

According to the 28th annual Forecast 2004 conducted by CIT Equipment Finance, contractors clearly are taking a wait-and-see attitude when it comes to making large investments in their equipment fleets. About 44% of interviewed contractors say they will purchase equipment in 2004. (Forty-nine percent said they would purchase equipment in 2003, and 45% said they would purchase equipment in 2002.) Contractors listed three top financial concerns: profit margins, cash flow, and cost of capital. After benefiting from historically low interest rates for the past several years, most industry leaders predict that financing costs will rise throughout 2004.

Also affecting acquisition decisions are tax benefits, the age and size of your business, your fleet age and financial strength, and your product-quality and cost-efficiency goals. Each factor should be weighed carefully. As such, acquisition decisions should include input from ownership, operations, and financial officers; tax advisors; and hands-on plant personnel.

Finally, evaluate your relationships with equipment dealers, manufacturers, and financial institutions. Strong relationships are critical in ensuring access to the most attractive financing terms. "If there is a single-most-important ingredient for business success, it is establishing a reputation for integrity and consistency in meeting your business obligations. That's why one of the three C's of credit is character," says Mark W. Olson, a member of the Board of Governors of the Federal Reserve System. During a recent presentation at a Cleveland, OH - based small-business development conference, Olson pointed to studies showing that the availability and price of credit (to smaller businesses particularly) is significantly affected by the nature of relationships with funders.

The Contractor/Dealer Relationship

Odessa, TX - based Jones Bros. Dirt & Paving Contractors Inc. boasts a more-than-50-year history and more than 300 employees. "In our region, business fluctuates significantly," says Jones Bros. Crushing Superintendent Allan Cowan. "You might be up three loaders and then down three loaders. Equipment moves around so fast. So, in many cases, we don't want to purchase outright when all of a sudden you may not need that piece of equipment." Therefore the company often prefers a lease with an option to buy. "Due to a close relationship with our dealer, we normally get 100% of the lease payments applied to the purchase." Cowan adds that the relationship is based on history, performance, and continuity between the contractor and the dealer.

Warren CAT, headquartered in Midland, TX, has maintained a close relationship with Jones Bros. for decades. The dealership sells and leases Caterpillar trucks, tractors, engines, generators, and more. "You have to know your customer's business and understand how their needs may change from year to year," says Warren CAT Sales Representative Blake Martin. "That affects the solutions we recommend. You have to know if the contractor is building equity in a machine or just buying time. It all boils down to how we can help them move and/or process material at the lowest costs per ton."

"After about six months of operation, we assess whether we need the leased equipment for upcoming projects. We take a close look at that because if you return the equipment, you're going to lose six months of payments, so to speak," continues Cowan. "Nearly 75% of the time, we end up purchasing the leased equipment. Initially that equipment had very few hours on it or was brand new, so we know that it's been well maintained."

Again to reinforce the importance of relationships, Cowan relates a story about acquiring an additional screen to make some alterations on a limited amount of existing material. "I thought that I would need the screen for no more than six months. The manufacturer wouldn't extend a lease/purchase deal, so I called one of my dealers. He delivered the identical screen the next day on a lease/purchase agreement. I ended up delaying the use of the screen for a month, and the dealer gave me a month's credit. At the six-month time frame, I'll see if I still need the screen and go from there. We like the flexibility and options that the lease/purchase provides."

Regarding cash purchases, Cowan stresses, "If warranted, that's the ultimate way to go." Over the last several years, Jones Bros. has acquired three fully automated telescoping radial stacking conveyors. Each unit was a cash purchase. These telescoping conveyors build fully desegregated stockpiles while eliminating the need for two haul trucks per crushing operation. "By eliminating a haul-truck stockpiling method, that's a $2,500 savings per week, per each of three sites. That's why we knew we needed to purchase the telescoping conveyors outright and use them forever. There's no benefit to renting or leasing equipment that saves you that much money."

Taking Ownership

Full-time equipment utilization is the key to profitable ownership. High utilization rates mean higher profits. How long and how frequently will you use the piece of equipment? Before making a substantial investment, consider the return that the equipment would bring when weighed against other investment opportunities. The construction industry's general rule of thumb is this: You must utilize your equipment at least 70 to 75% of the time (or 30 or more hours per week) to justify an outright purchase. Then you also must figure in maintenance and storage costs, property taxes, and any interest charges.

Experts stress that the cheapest way to acquire equipment is with cash. Even with a down payment and a well-negotiated installment loan, there is a lower cost of ownership than with a lease. Also, if you own a piece of equipment, you have the right to take depreciation benefits. If you lease, it is logged as a monthly expense.

Signed into law in May 2003, the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) is an economic stimulus package that encourages the purchase of new equipment. It features a depreciation bonus provision that allows you to depreciate or write off more of the cost of new equipment for the tax year in which you bought it.

Conduct a Lease-Versus-Purchase Analysis

You can analyze the costs of a lease versus a purchase by considering the timing of the payments, the tax benefits, the interest rate on the loan, the lease rate, and other financial arrangements. Finance professionals refer to this process as "discounted cash-flow analysis." It requires making certain assumptions about the economic life of the equipment and its salvage value and depreciation. To complete the analysis, tables and spreadsheets with built-in calculations and templates are available.

For a quick and easy comparison of lease and purchase costs, the simple worksheet below will help you in the assessment process by examining the factors of cost, cash availability, tax benefits, and obsolescence.