Today’s economic environment has changed the way consumers think about finance. Individuals have become more aware of their financial situations and spend more conservatively than in the past. Consumers have also become more aware of the types of financing available for major purchases, and the advantages and disadvantages of each.
The same economic factors that affect consumer spending are also affecting business finance. Financing is too often overlooked as a purchasing decision criterion; however, it is more important than ever to ensure that your organization chooses a payment method that is congruous with its business objectives and status. Understanding the available options will help you make an informed and educated financial decision.
Financing Versus Cash
The first and most basic decision is whether to use financing or pay cash. If your organization has capital reserved for equipment purchases, then it might make sense to use that capital to purchase the equipment to avoid paying interest on a loan or lease. This decision would not be made based on capital availability alone; other factors such as the rate of return on invested capital should also be considered.
Types of Equipment
If you decide to finance your purchase, the type of financing you select will depend on the type of equipment you are financing.
Capital equipment is defined as any equipment used to produce other products or services (commodities). Capital equipment purchases are usually $5,000 or more. The most common type of capital equipment purchased by a sleep lab is a PSG system (PCs, amplifiers, accessories). Because this type of equipment requires a large expenditure, and the equipment is used to perform sleep studies (which is the commodity being produced), PSG systems are classified as capital equipment.
|Tim Jordan, RPSGT|
CPAP devices and accessories, such as interfaces, are in a special category with regard to financing. Due to the nature of the asset, most finance companies are reluctant to provide terms longer than 18 months. Banks especially have difficulty financing CPAP devices and accessories due to the fact that the lessee (the lab) is not the “end user” of the equipment and does not maintain control of the asset. The majority of this type of equipment is financed on 12-month contracts. Some lease customers purchase CPAP equipment and accessories regularly, and prefer to aggregate the purchases and roll them into a lease on a monthly or quarterly basis.
With CPAP devices and accessories, there aren’t many unique financing options. Again, the maximum term a bank will usually allow is around 18 months. However, vendors and finance companies understand the nature of sleep labs and the reimbursement timeline, and can offer a 3- to 6-month deferral prior to the first payment being due. This gives the organization an opportunity to use the equipment to generate revenue before the lease payments begin.
Most sleep lab capital equipment purchases are leased. Lease financing allows sleep labs to acquire capital equipment with little to no money down and keep existing bank lines of credit intact for other purchases.
Larry Stokes, director of customer finance for Covidien’s Respiratory and Monitoring Solutions business unit, says that most sleep labs lease capital equipment with a 3- to 5-year term. “The longer terms help to spread out the cost of the acquisition and help to match expenses with revenue. The decision [on which lease term to choose] is typically made based on cash flow considerations. Lab owners tend to gravitate toward the longer terms so as to spread out the payments.”
Many diagnostic leases are quoted with a “$1.00 buyout.” This is essentially the leasing company’s way of writing a loan. The bank remains the legal owner of the equipment until the last payment is made, while the lab is the “tax” owner (responsible for listing the equipment on its balance sheet and depreciating it over its useful life). Depreciation is used to spread the cost of an asset over time, as the asset’s value decreases due to wear and tear, obsolescence, etc.
Some organizations may require an operational lease rather than a capital lease. An operational lease would be paid from an operational budget instead of a capital budget. This is an advantage for a hospital with a reduced or even frozen capital budget. Stokes says that accounting or budgetary constraints often play a role in the need for operating lease status, especially in a hospital setting. He compares an operational lease to an automobile lease. “The bank assumes a residual on the equipment and therefore is able to offer a lower payment. However, at the end of the term, the bank owns the equipment, not the lessee. The lessee has the option at the end of the lease to return the equipment to the bank or purchase for its ‘Fair Market Value.'” This option gives the lab more flexibility to upgrade, and may provide additional tax benefits compared to a capital lease.
Operational leases are not possible for CPAP machines and accessories. First, the lessee doesn’t maintain control of the units. The equipment is given to a third party (the patient) and leaves the bank with little recourse if the loan is defaulted upon. Second, no bank will risk assuming a residual value on these units as they have no perceived value in 1 year. Operating leases work best on assets that hold value, such as capital equipment.
The advantage to a lease as over a bank loan is that a lease preserves bank lines of credit for other purposes. A bank will typically not offer an operating lease option. Some organizations may be able to secure lower interest rates with bank loans due to existing relationships. However, leases are generally much simpler to process and more flexible relative to terms and options.
Lending institutions have recently tightened the parameters used to qualify loans. The criteria used to establish credit worthiness are determined by the size of the company and the amount being financed. Banks evaluate criteria such as the amount of time a company has been in business and the payment history on existing or past loans. This information is made available to lenders through Dun & Bradstreet (D&B). D&B maintains a commercial database containing business records, which is accessed by lenders to evaluate the risk of extending credit to a company. Negative credit items, such as open tax liens, will decrease the likelihood of loan approval.
“Banks usually request the last 2 years of financial statements or tax returns of the business,” says Stokes. “On the smaller labs, owners typically need to provide a personal guarantee for the loan (banks will check the owner’s personal credit). Hospital labs are much easier to approve with decisions made on the overall credit worthiness of the hospital. Since diagnostic deals for a hospital are small (in comparison to MRI, CT, etc), hospital deals get approved quickly.”
Check the online archives for more articles about sleep lab business practices.
The interest rate of the loan or lease is also determined by the size of the company and the amount being financed, as well as the length of the term. Interest rates on a lease can vary from as high as 15% on a small loan amount with a short term, to as low as 6.5% on a larger amount with a longer term. However, even the 15% rate on a 1-year term may still be a great deal. “Assume equipment cost is $10,000—the monthly payment for 12 months at 15% is only $891/month. That means the customer will pay $10,692 over the 1 year—only $692 in interest,” says Stokes.
Be sure to carefully consider financing options as part of your purchasing decision-making process. Making a smart financial decision requires research, and in some cases professional expertise. Financial specialists can help determine which option is the best fit for your organization’s financial situation and business objectives. Knowing you have made the best choice for your business makes it worth the time spent researching all options available.
Tim Jordan, RPSGT, is a clinical product specialist at Covidien’s sleep and oxygen division. He can be reached at email@example.com.