When contractors are considering purchasing equipment for their fleet there are several factors that must be considered. These factors include how the equipment will be purchased, if the equipment should be bought vs. leased vs. rented, the financial impact of the acquisition, the logistical considerations, and the disposal strategies. In this article, we will unpack the decision-making process and provide guidance on the factors to be considered.

The purchase of equipment can be accomplished by using cash to make an outright purchase, financing through a loan, leasing the equipment, or renting the equipment. Each method has a potential downside. The two primary factors to consider when it comes to acquiring equipment comes down to the financial impact and utilization. The purchasing strategy should align with the company’s risk propensity and should consider the impact on cash flow and debt leverage. When purchasing with cash, the company’s weighted average cost of capital (WACC) should be considered and compared to interest rates being offered on a loan. Typically, a loan carries a lower imputed interest rate than a company’s WACC. Most contractors are debt averse and so they end up using equity to finance purchases. Given the risk profile of contracting, companies should expect a return on equity of 20-40% which if far more expensive than traditional loans running at 8%. When financing with a loan, the company must pay the interest and that becomes a sunk cost. If a company chooses to lease the equipment, they are locked into a fixed payment for a time period. Lastly, if the choice is to rent, the company will see no residual value in the asset. Generally speaking, companies should buy equipment that will be used daily, lease equipment to hedge your bets against a market shift or change in work mix, and rent equipment for maximum flexibility.

There are additional financial factors that should be evaluated when considering a purchase. Utilization is imperative. Generally speaking a company should buy equipment that will be used a minimum of 1,000 hours per year (active time). The utilization may be lower on highly specialized equipment and that should be factored into the economics. The company should also determine if they have the available capital and whether or not the purchase is a good deal. The new lease rules (recognition on financial statements) should also be evaluated. The objective is to preserve the company’s credit while maximizing tax deductions and depreciation methods. The recommended approach is to conduct a five-year forecast of the equipment utilization and maintenance costs and compare it against a fixed return on net assets. It is also recommended to obtain guaranteed buybacks and negotiate warranties for purchased equipment. Logistical considerations should also be factored in. Questions to consider include:

• Do we have the available space to store the equipment when it is not in use?
• Do we have the ability and the licensing to haul the equipment?
• Do we have the ability to maintain the equipment?
• Are there special skills required of the operator?