—Sponsored article by Blue Chip Leasing
Having the newest technology on your floor is great, but if the systems aren’t in place to support the new equipment, the gain could be some what compromised. The best example I’ve come across recently is a manufacturer that installed a new machine but continued to use 10-year-old software.
“There are three pieces that will allow a manufacturer to be most efficient: the machine, the tooling, and the software. Your ability to be productive will only be as strong as the weakest link,” said Mark Sully, product specialist sales executive for Autodesk Inc. (formerly Delcam).
A few mutual customers recently upgraded to new CAD software via a lease. Machine Shop A, a Tier 3 supplier to the aerospace industry, just bought a new 5-axis machining centre, but had not upgraded its software system in many years. The new machine improved cycle time, but not as dramatically as anticipated.
It wasn’t until new software was implemented, at a cost of roughly $12,000, that the benefits of the new equipment were fully realized. In this case, the cycle time for a part that had been 2.5 hours was reduced to 25 minutes.
Machine Shop B, a supplier to the telecom industry, recently installed a 5-axis machine for producing a number of different part generations that were taking eight hours to program and had a cycle time of 12 hours.
Its investment in new CAD software was approximately $30,000, and the result was a reduction in programming time to only three hours, with an eventual cycle time of five hours. The savings for this shop were so dramatic that the ROI for the machine, which was originally pegged at 24 months, became less than one year.
In both cases, the software was financed over a 36-month term, which is an industry standard for software, as opposed to the usual five years for equipment.
Growing companies taking on more work have a significant amount of additional costs that can’t be financed, such as material, consumable tooling, and labour. However, it’s often during product development—yet another cost that cannot be financed—that cash is of its highest value and best used.
Securing financing for software isn’t as easy as it is for a hard asset with a good resale value, for an obvious reason: In the event of a default, there’s nothing to repossess and resell. This gives the lending institution no real exit strategy. These cases are considered covenant lending, meaning the lender reviews the manufacturer and bases its approval solely on whether it can support the entire amount of the transaction.
However, a lender with experience in the manufacturing industry understands the hard value of the asset isn’t nearly as important when it is measured against the increases in productivity and efficiency that will eventually show up as higher profits.
It’s also important to note how the software industry is changing because of additional benefits from a taxation perspective. Whether it’s purchased outright or financed, software is typically owned by the user but requires yearly maintenance for upgrades. This means the manufacturer pays a large, upfront cost followed by significantly smaller fees for maintenance.
However, the market is changing, and some of the largest software developers are moving to a subscription model. In this model, even though the price of the software is lower (in some cases up to 75 per cent), once the subscription expires, a new one must be purchased or leased.
One method of handling this type of transaction is to set it up as an operating lease. Accountants classify leases into two main categories: capital leases and operating leases. From an accounting perspective, capital leases are treated similarly to an outright purchase.
An operating lease, on the other hand, is a contract that allows for the use of an asset, but does not convey rights of ownership of the asset; the leasing company maintains ownership. The software is not put on the books as an asset, but instead accounted for as a rental expense in what is known as off balance sheet financing.
Operating leases have tax incentives because the payments made over the year are business expenses and don’t result in assets or liabilities being recorded on the balance sheet. The yearly cost essentially reduces operating income, and the tax savings come from a reduction of that income.
The current federal corporate tax rate is 15 per cent. So, for example, if a software lease is $1,000 per month, the savings in taxes are approximately $1,800 (15 per cent of $12,000). That being said, remember it’s important to always have a discussion with your accountant or financial adviser before any transaction is finalized to ensure you have a complete understanding of how it will be handled from an accounting perspective.
For Canadian manufacturers to remain competitive on the world stage, investing in new technology is very important. But it’s just as important to ensure the new technology is being used in the most efficient manner possible. Sometimes a small, additional investment will be the one that makes all the difference.
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 column originally appeared in the March 2017 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.