Rx for CapX - Part III
When it comes to capital expenditures, or as we say in banker terms “CapX”, timing becomes an important part of the process. In the earlier part of this series, we discussed the importance of involving your banker and allowing enough time to plan for the purchase. Taken together, the business owner will come to a more informed decision.
Once a purchase price has been established—and don’t forget to include items such as freight, taxes and set up costs—you can complete the process of financing options. A good starting point is determining the useful life of the equipment. There is no hard and fast rule that applies but here are a few of mine:
- For vehicle purchases such as a car or pick-up truck I recommend a term loan not to exceed 4 years. Get the vehicle paid off before you need to replace it. By doing this you can reduce future maintenance and upkeep costs.
- Heavier rolling stock such as semi-trucks and trailers can extend to 5 years. Given wear and tear of these units, it’s best to keep the debt structured in a way that allows for a good residual value once the loan is retired.
- Software and hardware vary but a good starting point is to find a 3 or 4-year loan that is paid off before the technology becomes obsolete.
- Building improvements vary but can range anywhere from a 5 to 10-year amortization period or may be rolled into a new commercial real estate mortgage. If it’s an expansion to the existing building to accommodate more equipment, it’s best to look at a construction to permanent loan.
Each one of these scenarios is uniquely different but have one element in common: planning. Allowing sufficient time for your CapX decisions gives your banker the time to help you structure a loan that best fits your cash flow. Making sure your loan is properly structured for your CapX program is a good prescription for everyone!