Complex projects require careful management of working capital
—Sponsored article by Blue Chip Leasing
Reprinted from the May edition of Canadian Metalworking
When I started in the manufacturing sector in the early 1990s, I was working for my family business, importing and distributing Japanese machine tools. Because we were selling high-end equipment, we had a full complement of service technicians and application engineers to support our sales staff, similar to most current sellers of machinery and equipment.
For the most part, we sold standalone machines, but on more than a few occasions customers were looking for additional services beyond simply delivering and setting up a machine, and one of those services was offering turnkeys.
Turnkey refers to a system that’s ready for immediate use. The word is a reference to the fact that the customer—upon receiving the product—just needs to turn the ignition key to make it operational.
It means supplying a complete cell capable of running finished parts, including design and programming of the part, automation, fixturing, tooling, and, of course, the machines.
When you consider the scope of work required to supply such a service, I can tell you firsthand it’s considerable. Therefore, the associated costs were also considerable.
However, there was another issue surrounding the selling of these turnkey systems: How did we want to get paid? Typically, we required a fairly large deposit. We took 30 percent with the order, and that covered our commitments for the equipment, tooling, and accessories required to make the system work, because those suppliers would also expect deposits.
We then started the engineering work and prepared programs, drawings, and system designs. Once these tasks were completed, we expected another 30 per cent upon design approval.
The next step was to actually put the system together on our floor and do a full run-off for the customer to demonstrate the system was in fact capable of manufacturing finished parts within the defined tolerances. Once that was completed, we again invoiced for another 30 percent.
The final 10 percent was payable once the system was delivered and functioning on the customer’s floor but most importantly, 90 percent had been paid before a single part was ever created.
The financing option
Having been involved in lease financing for more than six years, I can tell you one of the reasons customers choose to finance their purchase—whether they’re working with their own bank or with an alternative lender—is cash flow.
A busy manufacturer has a number of uses for working capital; it needs money for tooling, material and wages, and it normally has customers who don’t always pay on time.
When it comes time to add a piece of new machinery or an entire system to handle the extra work it has landed, the manufacturer finds it is nearly impossible to pull that kind of money out of working capital.
If the new machinery is financed as opposed to purchased outright, and the lender is familiar with and understands the industry, the manufacturer can put a loan or lease in place and in turn, pay the seller directly.
Essentially, the transaction is pre-funded, meaning the lender will make the step payments to the seller and the manufacturer will just start the lease and make the regular monthly payments.
Once the transaction has commenced, the only payments the manufacturer is responsible for are the ones made while the system is being prepared, as opposed to having to lay out large amounts for the purchase price.
One of our good customers that bought two CNC lathes with automation, also opted for a robot to load/unload parts, along with a conveyor system.
Once we had approval along with signed documents, we released the deposit and initiated the lease. The total cost was approximately $300,000 and the manufacturer’s monthly payments were about $5,000. We also made some progressive payments as the cell’s supplier received design approval, performed run-off on the seller’s floor, and then performed runoff on the manufacturer’s floor.
The time from order to the time of delivery and acceptance was about five months, so the manufacturer made five monthly payments totaling $25,000 during the build time, which was far easier to manage than the deposit alone to buy the equipment, which would have been $90,000.
The reality was more than a few factors had to be addressed for us to be in a position to get this done for our customer. We needed to ensure the credit was supportive, which it was; the lender needed to have confidence in the seller (in this case one of the most established dealers in Canada); and the lender had to understand the industry and be prepared to pre-fund the transaction.
There’s no doubt that, regardless of size or balance sheet, all manufacturers struggle with cash flow, so they should explore every avenue for investing in new equipment without having to pull the money from working capital.
Ken Hurwitz is senior account manager with Blue Chip Leasing Corporation, an equipment finance company in Toronto. Ken has years of experience in the machine tool industry and now works to help all types of manufacturers either source or tap into their own capital to optimize their operations. Contact Ken at (416) 614-5878 or at via email. Learn more at www.bluechipleasing.com
This article originally appeared in the May 2016 edition of Canadian Metalworking.
The article is part of the Financial Management Success Centre, showcasing strategies to access working capital, reduce costs, and leverage the value of shop floor equipment.