Ask Andi: Need help to manage equipment costs. We have a lot of equipment and a lot of loans to go with them. We stretch to buy more. The upfront payments are killing us. It feels like we never get ahead. Help!
Thoughts of the Day: Manage equipment costs to help grow the business and identify areas for improvement. Getting control over equipment costs can be challenging. You need to know what your equipment is worth to you. Build a strategy to maximize value and increase income. Manage cash flow by understanding the real cash cycles of your business. Plan your way out of debt with a multi-year strategy.
Manage equipment costs by analyzing profitability
It’s often hard to know what equipment costs or which pieces are the most productive. Your Profit and Loss Statement gives an incomplete picture. Getting answers may take a bit of work, but will yield insight. Such information helps you to make better decisions when most needed when going forward.
Start with a list of all of your pieces of equipment. Note what each piece costs: purchase-including principal and interest; lifetime maintenance, repair, and operating costs; lifetime labor. Not sure? Take a guess. Add up the total.
Estimate income earned per piece over its life. Again, if you have to, guess. Use an all-in number including labor income, since you built labor into your cost side.
Calculate the payoff ratio which helps you get closer to the real value of each item on your equipment list. Divide the lifetime income of each item by its total cost – purchase, operating, and labor. This is a rough estimate of an equipment payoff ratio. The higher the ratio, the better.
Do the most with the least
Go down through your equipment list. Circle the winners (top 10% – 20%) in each column: lowest cost, the highest income, and highest payoff ratios. Pieces of equipment that have 2 or 3 circled (cost, income, payoff) are home runs.
Think hard about equipment that has a low payoff ratio. It may be time to increase prices, replace inefficient equipment or change how equipment gets used. Boost the payoff ratio on every piece of equipment that you can.
Focus on high payoff with the highest income to manage equipment costs. Strategize how to increase sales of these pieces. Find out why customers buy this type of service. Look for examples of who else might want to buy. Make sure you have enough of the right equipment in good repair to meet customer demand.
Sometimes a piece of equipment may be in high demand for a short period of time and then sit around the rest of the year. That can be a real waste of resources. Line up places you can rent from without making a major commitment or look for more steady income producers.
Quantify equipment costs
Buy and manage equipment costs at the right time of the year. Often owners buy equipment when they feel flush with cash. That’s also about the time that the slow season starts, just when they need to be hanging onto cash.
Make purchases right before the season starts up. Cash on hand can down after a slow period. If down payments seem unaffordable consider leasing than purchasing. Avoid big down payments. Make sure to select financing terms that are shorter than the usual life of the equipment.
Set revenue goals for the next 3-5 years. Break that down by types of work, types of clients. Which categories are likely to need additional equipment or tools that aren’t currently in the business? What equipment will need to be retired or replaced?
Match an equipment buying plan to your revenue plan. Make sure you’re buying the right types of equipment. Keep current assets to current liabilities ratio over 2.5, and current debt to equity ratio to under 4. Compare annual financing costs, including principal, to projected revenue and expenses to ensure a profit after paying off each year’s loans. Hold off meeting with sales reps until you’re absolutely sure what you need and can afford. Keep bets low on new untested equipment until you’re sure customers want and will pay for it.
Looking for a good book? Lease or Buy? Principles for Sound Decision Making (Financial Management Association Survey and Synthesis Series, by James S. Schallheim.
