Last Updated on
July 12, 2023
By
Excedr
It’s all about keeping costs fixed and minimal. While inflation has shown some signs of slowing down, it remains near its highest level since the early 1980s. To continue its effort managing inflation, the Federal Reserve will likely continue increasing its benchmark interest rate throughout 2023.
The Fed hiked the interest rate by a quarter percentage point in February, 2023, and then again in March and May, pushing the federal funds rate to 5.00% to 5.25%.
These are the highest numbers since October 2000, and mark the tenth increase in a process that began last March, 2022. There is little indication the hiking cycle is nearing an end, and many believe that inflation will be with us for the foreseeable future.
How does inflation impact interest rates, and how does an increase in the price of goods and borrowing costs affect businesses?
Firstly, inflation and interest rates tend to move in the same direction, as interest rates are the primary tool used by the Fed to manage inflation. There is typically a lag between inflation and interest rate hikes because the central bank requires data to estimate future inflation trends, and the interest rates it sets take time to fully affect the economy. Secondly, increases in pricing and borrowing costs make it more difficult for businesses to manage cash flow properly.
By increasing borrowing costs, the Fed tries to encourage consumers and businesses to spend less and save more. But there are items businesses often need to acquire despite current interest rates, specifically equipment used to manufacture a product, provide a service, or sell, store, and deliver products.
This is especially true in industries that rely heavily on equipment to operate. The life sciences and healthcare industries are perfect examples, where businesses use a wide range of lab equipment for research and development (R&D).
Even without inflation, lab equipment can be costly to purchase and maintain, with large upfront down payments eating into the company budget. If inflation drives prices higher, and rising interest rates make borrowing more difficult—not to mention increasing lead times—lab equipment buyers are going to continue to face added challenges securing new equipment for their businesses.
Yes, managing the impact of increasing interest rates and inflation can be difficult, but there are some ways to help manage the current environment in 2023. Rising interest rates are not all doom and gloom though. Shrewd and savvy companies can make it work.
As inflation fluctuates and interest rates climb, it can be difficult deciding when you should finance equipment to grow your business. Let’s briefly go over the general effect rising interest rates and inflation can have on equipment financing and leasing.
When interest rates rise, they can negatively impact buyers and their ability to service their debt, in turn affecting their cash flows. And as inflation goes up, the cost of goods increases, often leading to sticker shock for buyers after a long period of low-interest rates and inflation.
Considering these effects, is it possible to combat rising interest rates and manage your cash more effectively in the face of inflation and higher prices?
Here are some tips to help business owners manage equipment procurement in the current environment (they are also reasons you might not want to hold off on financing essential business equipment):
You can start combating rising interest rates and inflation by locking in your rate, whether you’re leasing or financing the acquisition of lab equipment through a loan. If you can lock in a fixed-rate equipment financing now while keeping your money in the bank, you’ll be better off as rates go up.
We recommend you weigh the cost of leasing a piece of equipment against what you can save or gain using the equipment for your business. Ask yourself the following questions to get a better understanding of your situation:
If the equipment can help you with any of these areas, you have a compelling reason to acquire the item for your business. Rather than purchase the machinery, consider a lease instead. It can be essential to lease or finance equipment sooner rather than later in the current economic environment.
Doing so allows you to lock in your interest rate now, which will most likely be lower than the interest rates in the coming months, based on the current expectations economists have that the Fed will raise interest rates further in 2023.
It can help to shop for competitive rates among reputable lenders and consider short-term rate locks to protect yourself from interest rate increases. Leasing is also a good option. Most importantly, if you’re in need of new equipment, the sooner you can lock in your rate the better, because rates will likely increase throughout the remainder of 2023.
With high-interest rates and increased pricing for various equipment, leasing is often an attractive option for customers looking to acquire lab equipment. However, lease pricing goes up when rates go up, so it’s in your best interest to get a lease as soon as possible.
A lease signed today locks in the current rate as well as today’s equipment price, and unlike lines of credit and variable rate loans, leases are typically fixed payments based on fixed interest rates.
Equipment financing solutions often offer more flexibility on term length when compared to other lending options. By locking in a 2-6 year term with rates before they go up, you lock in a fixed payment that won’t be available next year, next quarter, or possibly even next month.
Although it’s hard to predict whether inflation will rise or fall—it has been trending downwards in recent months—it’s quite possible it will rise again and continue to rise. At the end of the day, we have no idea what might happen, an uncontrollable or unpredictable event could happen, causing it to rise again.
If inflation does rise, it will drive price tags higher, whether its equipment, fuel, energy, or food. So, assuming inflation will continue to rise again, the price you pay for equipment may be lower now than in the near future. Acquiring equipment today will cost a business less than purchasing the same equipment tomorrow.
With that in mind, you can combat rising rates and inflation by leasing or financing sooner rather than later, similarly to locking in your interest rate.
With rising interest rates, it’s important to find a leasing company or lender who you can trust to offer a loan or lease that’s customized to your needs.
It can help to investigate all your options when you’re choosing a financial partner, from commercial banks to independent leasing companies. While conventional banks are a familiar option, they aren’t always as easy to work with when it comes to equipment financing and leasing.
Securing a loan or line of credit can be extremely difficult if you don’t have exceptional credit and multiple years back-to-back revenue and profit growth. Their terms can be quite restrictive too, which means, if you’re approved, there is more on the line if you can’t perform under the terms of the loan.
Equipment financing companies like Excedr, on the other hand, can often extend leases to companies that banks don’t see as qualified. The lease terms do not generally include restrictive terms such as debt covenants, collateral, IP pledges, or equity participation.
When the Federal Reserve's federal funds rate increases, it affects lenders by increasing borrowing costs. As a result, traditional lenders may lower the loan-to-value ratios (LVR) they accept during times of higher interest rates. This implies that a larger deposit is required for business loans and equipment loans, in addition to the security needed to collateralize debt.
In such situations, businesses experience significant cash outflows before they can generate revenue or productivity gains from the asset.
Leasing, on the other hand, does not necessitate a large deposit, and monthly payments may be lower than those of traditional bank loans due to the lessor's investment in the asset's residual value. Additionally, leasing frequently allows a company to lock in the interest rate for the lease period, ensuring that payments remain constant even if interest rates rise further. In this way, leasing reduces your capital expenditures.
Regular maintenance is usually necessary for lab equipment. If maintenance schedules are not followed, the equipment may become inefficient or even break down, resulting in more costly repairs or replacement.
Leasing equipment usually takes into account its useful life and optimal maintenance schedule, allowing the lessor to either dispose of or renew the equipment for a "second life" after the lease ends.
By considering the maintenance and repair costs required to maintain equipment in good condition, the total cost of ownership (TCO) can be reduced, and the responsibilities and expenses related to buying or end-of-lease activities can be minimized.
For most businesses, equipment's value lies in its operation rather than ownership. This makes equipment accounting a critical part of cash flow management.
When a company purchases equipment using traditional methods such as with cash, depreciation and interest expenses are tax deductible, but the principal payments remain on the balance sheet. Depreciation deductions must adhere to a depreciation schedule in these scenarios.
IFRS 16 and ASC 842 now treat operating leases like an asset with interest and depreciation deductions. However, unlike a purchase or finance lease, only the equipment's present value is depreciated.
In other words, when a company buys equipment using traditional financing methods, such as cash or a loan, they can deduct depreciation and interest expenses from their taxable income. However, the principal payments they make on the equipment remain on their balance sheet as a liability.
IFRS 16 and ASC 842 are accounting standards that treat operating leases as if they were an asset, allowing companies to claim depreciation and interest deductions. Unlike with a traditional purchase or finance lease, only the present value of the equipment is depreciated over the lease term, rather than the entire cost of the equipment.
This change in accounting treatment means that operating leases can now be more advantageous for companies than traditional financing options, as they can reduce taxable income, improving cash flow.
Furthermore, there is a low-value or short-term exemption for leases that allows the total cost to be taken as a deduction in the profit and loss section. This provision allows businesses to take the entire cost of certain leased assets as a deduction in their profit and loss statement, rather than depreciating the asset over time.
This can be beneficial to businesses as it can also work to reduce taxable income and improve cash flow.
Many businesses are not aware of this provision and mistakenly believe that only assets worth less than $5,000 qualify for this exemption. However, the actual amount may be higher depending on the materiality of the asset, which refers to its relative importance or impact on the financial statements. Additionally, this exemption can apply to multiple low-value assets, not just a single one.
Businesses should carefully evaluate their lease agreements to identify any qualifying assets and take advantage of this exemption to minimize their tax burden.
When a company leases equipment, they benefit from the lessor’s expertise and knowledge of the equipment being leased. This expertise, combined with appropriate lease terms, can result in a faster financing arrangement than traditional bank loans, which can be particularly beneficial when supply chain delays are expected and interest rates are increasing. There are a number of funding options for biotechs, and putting yourself in the best position to raise funds should be prioritized.
This means leasing can allow businesses to acquire new equipment faster and begin operating more efficiently and effectively sooner.
Additionally, by signing a lease agreement, companies can secure the equipment they need to operate over a period of multiple years, during which inflationary pressure is likely to continue, providing stability and predictability for a business’s expenses as they plan their budgets and cash flow accordingly.
While we believe in the benefits of leasing, it’s important to consider several factors before deciding whether to rent, lease, own, or lease-to-own equipment. Different financial services can be suitable depending on a company’s specific situation.
For instance, rentals can often offer the greatest flexibility, but renting might not always be the most cost-effective solution in the long run. To make an informed decision, consider factors such as the type of work that needs to be completed, the time the equipment is required, the budget available, and the financial reporting implications.
Considering these factors, a business can choose the most suitable option for its needs.
For example, renting may be the most appropriate choice if the work that needs to be completed is short-term and the company has a limited budget.
However, owning or leasing may be more cost-effective if the equipment is needed for a more extended period and the company has the financial resources to support it.
The best thing you can do is weigh the pros and cons of each option and consider multiple factors when deciding how to acquire equipment to ensure that the company is making an informed decision that aligns with its needs and financial situation.
It's important to keep costs fixed during tough economic times. High inflation and interest rates can hurt business revenue and expenses, especially if revenue decreases while costs continue to rise.
Therefore, laboratory equipment buyers in the life sciences and biotechnology industries should proactively manage their financing costs.
Companies should consider leasing and finding a reliable financial partner to reduce the impact of inflation and rising interest rates. Buyers can make informed procurement decisions that support research and development goals by exploring all equipment acquisition options and locking in interest rates.
Through leasing, businesses can shield themselves from inflationary trends and benefit from fixed-rate lease payments. And as inflation continues, future lease payments can be paid using "cheaper" dollars, ultimately reducing the financing cost in real dollars.
Leasing can help guide companies through rough economic waters by enabling deferred cash outlays and providing fixed-rate payments, ultimately reducing financing costs.
Interested in partnering with Excedr and taking advantage of equipment leasing? Let us know. We provide biotech and medical equipment financing—in the form of long-term leasing—to a wide variety of life sciences and healthcare companies.