Equipment finance is becoming an increasingly viable option to free up working capital and increase cash flow. But equipment finance is a competitive market and it pays to shop around. Take a look at what equipment finance can do for your business’ cash flow.
One of the biggest issues facing SMEs and middle market companies is sourcing the working capital to fund and grow their businesses. More than 80 percent of SMEs report they are planning to take on further borrowing in the coming six months, pointing to strong optimism in this part of the market. About seven out of every 10 say they will seek to raise borrowings for the purpose of funding working capital.
Given that the small business market can be viewed as the ‘sweet spot’ in the business lending market right now, banks have focussed their attention on providing more flexible working capital solutions to these ambitious businesses. One of the working capital products available to fund growing businesses is equipment finance.
Broadly speaking, the term equipment finance comprises four basic product groupings: finance lease, operating lease, commercial hire purchase, and chattel mortgage. Non-lease finance (commercial hire purchases and chattel mortgages) accounts for more than 60 percent of the overall market. However, only about 30 percent of customers report having these products. This is because in reality the term ‘lease’ is frequently used as a synonym for a range of equipment finance products available, without discerning between the individual products on offer.
The Australian equipment finance market is characterised by multiple providers competing aggressively for a share of a growing customer pie. The market grew by a staggering 26.4 percent (to $29.4 billion) during the 12 months to June 2006. This growth rate exceeded the 18.3 percent growth experienced by the broader business lending market. During 2005/06, equipment finance comprised 5.7 percent of total business lending in Australia.
The big banks do provide equipment finance of course, but in many cases equipment finance tends to be quarantined in separate or subsidiary divisions, away from the mainstream relationship lending business. This somewhat segregated approach by banks, mostly still focused on ‘bricks and mortar’ lending solutions to smaller businesses, is not responding quickly enough to demand for flexible equipment financing. This, in turn, is leading to explosive growth in third party originator (broker) activity in the segment, generated principally by businesses wanting different collateral conditions for their working capital borrowings.
Moreover, for the bank providers of equipment finance, their customer share of the equipment finance market is, in most cases, significantly less than their customer share of both transactional banking and term lending. This is partly due to the deliberate strategy of keeping equipment finance in separate or subsidiary divisions, but it is also due to the presence of non-bank competitors such as GE Commercial and vendor financiers (that is, sellers of equipment who also provide equipment finance) that have captured the imagination of many customers.
One of the main reasons behind the popularity of vendor financiers is the belief by a significant portion of customers that vendor financiers deliver benefits to them not available from other financiers. The key benefits often cited here are ease of transaction execution, overall pricing, and asset maintenance programs. For the most part, these customer perceptions are accurate. However, whether vendor financiers deliver a pricing advantage on new equipment is debateable and is often dependant on the cross-subsidisation between the cost of the equipment and the cost of financing. In other words, it pays to check how the cost of equipment might be affected by financing it through the seller.
Customer Benefits of Equipment Finance
The benefits to the customer of using equipment finance are typically well understood by them, with cash flow benefits and capital preservation perceived by some 50 percent of customers to be the foremost attractions.
Just under one-third of customers view the ability to deal away from their incumbent lender as being a benefit of equipment finance. Such behaviour is driven by the belief that transacting equipment finance with their incumbent lender will ‘use up’ the capacity the customer has under their secured funding lines. GST and accounting treatment are also among the product attributes that are seen as important to the customer.
Customers rank after-sales service and credit requirements as their most important attributes in the delivery of equipment finance, from a list of 10. Price is ranked as the fourth most important attribute, while innovation is generally regarded as the least important.
Customer satisfaction is, to a considerable degree, inverse to importance. That is, customers generally report least satisfaction with the most important aspects. Credit requirements and after-sales service, which are most important attributes, are also the ones customers were least satisfied with. The attributes customers tend to be most satisfied with are product and price, which are lower down the list in terms of importance.
Brokers control a significant portion of the equipment finance market, being used by an estimated four out of 10 enterprises to source their equipment finance needs. Enterprises that use brokers often use the services of more than one broker and source two-thirds of their total equipment finance needs through this channel. The usage of brokers is particularly high among SMEs where more than half report having used a broker to source equipment finance.
Customers view the time saved by not having to shop around (they believe the broker does this), and reduced pricing as the two highest rated benefits of using a broker. In reality, brokers rarely shop around, although they do have a sound knowledge of what is on offer from the selected lenders they deal with regularly. The customer assumption that utilising the services of a broker will deliver the best price is to some degree a myth. Any pricing concessions that may be gained by brokers infrequently flow through to the customer, being usually retained by the broker.
Although many SMEs are using brokers to source equipment finance, more than three- quarters of these businesses say they would prefer to deal directly through their principal bank, all else being equal. That they are not doing this suggests the use of brokers is essentially a default choice for most customers, because their needs are not being met by their incumbent bank.
The Australian equipment finance market is a competitive environment with a range of bank and non-bank providers battling to take advantage of strong customer demand. Equipment finance is a product well-suited to the needs of growing businesses looking for a flexible working capital funding solution that doesn’t rely on traditional bricks and mortar security. The equipment finance product remains relatively uniform across providers but service support often differs. With providers intent on remaining price competitive, customers should definitely shop around to find the product which is right for their needs.
—Zoran Knezevic is financial markets analyst for East & Partners, a market research and advisory firm in the business banking markets of Asia Pacific. The firm carried out a comprehensive analysis of the Australian equipment finance market, which culminated in the publication of a multi-client market analysis report in October 2006. This article showcases some of the key insights gained during this rigorous analysis.
Cash Flow Solutions
Finance lease: this provides you with the use of the equipment you need for an agreed fixed period. This solution provides for 100 percent of the equipment purchase price, with tax-deductible repayments fixed and structured to suit your business’s cash flow. At the end-of-the-lease term you have the ability to upgrade to new equipment or refinance the existing equipment.
Commercial hire purchase: this facility enables your business to borrow up to 100 percent of the equipment price, or less if you wish to pay a deposit upfront. This solution provides immediate use of the equipment in exchange for monthly repayments, which can be structured to meet your budgetary needs.
Goods mortgage: as an alternative to leasing or hire purchase, a goods mortgage is a fixed interest rate loan supported by a mortgage over the relevant equipment. The business takes immediate ownership of the equipment. This solution is particularly favourable for businesses wishing to retain the equipment at the end of the term and account for GST on a cash basis.
Novated lease: when structuring employee remuneration packages, a novated lease is an attractive way for businesses to structure the finance of an employee’s company car. The employee enters into a lease with its financial institution and completes a deed of novation with their employer. The employer can choose their preferred vehicle and transfer the lease to a new employer if they change jobs. This means the business is not burdened with an unwanted vehicle.
Equipment rental: this is suited to businesses seeking to rent or hire without the obligation of ownership. Equipment rental is a versatile option for acquiring new technologies such as computers, telephony and other equipment that generally has a short lifespan.
—Source: Sam Turri, head of equipment finance at St George.
You can also free up working capital by signing up to CreditorWatch to expose bad debtors and be alerted when the businesses you trade with fail to pay.