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Rising Interest Rates: Financing Now Can Earn Huge Returns

Given the rising interest rate environment, many businesses planning equipment acquisitions are faced with crucial decisions. 

Federal Reserve officials have forecasted an average federal funds rate of 1.9% for 2022. The federal funds rate serves as a benchmark interest rate that determines the cost of borrowing for many loans. After the recent May 4th interest rate hike (the largest increase since 2000), the federal funds rate currently sits at 0.75% to 1.0%, indicating that interest rates are likely to increase by an additional 1% during this year. 

As such, we find ourselves asking the question: Is it better to finance now at a lower rate, or finance later at a higher rate? We believe that choosing to finance now at a lower interest rate is a great option for most businesses.

From an interest savings perspective, it will always be preferable to finance now rather than later during a rising interest rate environment. 

However, businesses must decide whether the interest savings is worth the upfront cash flow tradeoff. The decision to finance now or finance later ultimately comes down to how highly the business values cash flow in earlier months.

Scenario #1: How much will a 0.50% increase cost me?

  • Business A and Business B finance $1MM of equipment with a 60-month term.
  • Business A chooses to finance now and locks in a 6.00% interest rate.
  • Business B chooses to finance in 12 months and locks in a 6.50% rate (as compared to 7.00% in scenario #1).

Related News: The Fed recently approved a 0.50% interest rate increase to fight inflation and some Fed officials are advocating for raising the target closer to 2.5% by the end of the year.

In the above scenario, Business A saves $28.0k of interest, as compared to Business B, the business that chose to finance later. Business A begins making payments today and makes $231.9k of payments during the first year. Business B chooses to finance later and doesn’t begin making payments until the 13th month. 

Business A, the business that chooses to finance now effectively receives $28.0k of interest savings for the $231.9k cash flow commitment during the first 12 months, allowing for an effective rate of return of 12.1%. 

Additionally, Business B will have to make $234k of payments during the 6th year, while the company that chooses to finance now will not.

Scenario #2: How much will a 1.00% increase cost me?

  • Business A and Business B finance $1MM of equipment with a 60-month term.
  • Business A chooses to finance now and locks in a 6.00% interest rate.
  • Business B chooses to finance later and waits 12 months and locks in a 7.00% rate.

In the above scenario, Business A, the company that chooses to finance now saves $56.2k of interest, as compared to Business B. Business A begins making payments today and makes $231.9k of payments during the first year. 

Business A effectively receives $56.2k of interest savings for the $231.9k cash flow commitment during the first 12 months, allowing for an effective rate of return of 24.2%. 

Additionally, Business B will have to make $237k of payments during the 6th year, while the company that chooses to finance now will not. 

Financing Before Additional Rate Increases is the Shrewd Move

In both of the above scenarios, the business that chose to finance now was able to secure a significant reduction in interest expense, as compared to the business that chose to finance later. When the interest rates increased by 1.0%, Business A was able to save $56k in interest, implying a 24.2% return on the cash flow required for the first 12 months of payments. When interest rates increased by 0.5%, Business A was able to secure a more modest interest savings of $28k, implying a 12.1% return.

If you are a business with liquidity to pay upfront, financing before the industry increase is the smart way to go because it has the potential to save you substantially in interest expenses. For more interest rate information, schedule a strategy session with EFFI to consult an expert in business financing.

5 Reasons Equipment Financing Makes Great Business Sense

At first glance, it may seem unfeasible to utilize equipment financing as an option over paying directly with cash. Especially in the case of a loan, as you’ll end up paying more due to accruing interest over the repayment period. While this may be true in many cases, there are real, notable benefits that come with equipment financing.

Here are five reasons equipment financing makes great business sense –

  1. Improves cash flow
  2. Improves credit score
  3. Low-interest rates
  4. Higher quality equipment
  5. Greater potential for growth

Improves Cash Flow

As you probably know, cash is king. It is a foundational element in any business. The primary benefit of using cash for purchasing equipment would be the fact that it’s a straightforward process. The transaction is carried out instantly, there’s comparatively very little paperwork involved, and you acquire full ownership of the equipment upon purchase.

It’s precisely this importance of cash that gives equipment financing the primary benefit of improving cash flow.

A significant part of business expenses already demand a steady supply of cash. This makes it crucial to maintain cash reserves at all times. Therefore, using up a substantial portion of your available money on equipment may not be the best strategy for your business as a whole. Financing is an option that can free up fluidity for other budget requirements in different areas of your business.

Making smaller payments over time is more manageable than paying out a larger lump sum upfront. Equipment financing ensures that your business will always have cash when it needs it. In the event of an emergency or the presence of an opportunity, you will be prepared with cash.

Improves Credit Score

Using equipment financing is a great way to improve your business’s credit score. A higher credit score enables your business to acquire loans more successfully, on better terms, and with lower interest rates.

Leveraging low-interest rates on equipment has the potential to create larger returns on your equipment investments.

Seeking equipment financing and paying it off promptly significantly develops your business’s credit score. It can make future business financing a breeze and act as an essential safety measure in down times. Being able to acquire a loan at a low-interest rate readily can be very useful down the road.

By contrast, not having an acceptable credit score makes acquiring future financing in a timely and favorable manner much more challenging.

Low-Interest Rates

Businesses can attain equipment financing at interest rates starting at 2%. This range is primarily dictated by factors such as your business’s length of operation, current cash reserves, and credit score. This rate can often prove favorable depending on the equipment you need financing on.

Leveraging low-interest rates on equipment can put your business in a better position. In some cases, you can create larger returns than the cost of the interest paid on financing the right equipment.

This, of course, is something that has to be appropriately analyzed. Consulting a financial advisor about the feasibility of financing will help you make an informed decision.

Schedule a strategy session with EFFI to consult an expert in business financing.

Higher Quality Equipment

High-quality equipment does not come cheap. This leaves many businesses with the options of settling for substandard equipment, jeopardizing their quality, using up most of their cash reserves, or saving up for machinery (which will likely take time).

Higher quality is typically the better option rather than sacrificing for cheaper options, and oftentimes end up saving you money in the long run with better performance and durability.

Equipment financing solves these problems. It allows your business to procure higher quality, more expensive, but much-needed equipment on a flexible long-term payment plan.

Greater Potential For Growth

This is especially true for newer businesses that are looking to expand. The right equipment could be the push your business needs to propel it in the right direction.

For cash crunched businesses, equipment financing can make things a lot easier. A proper payment plan will allow you to use the gradual returns from the equipment to pay off the purchase cost. This can lead to a self-sustaining payment system, where you get ownership of the equipment once payment is complete.

It’s also important to consider that sudden opportunities that require cash may present themselves from time to time. Lack of cash can allow the chance to slip away while you attempt to gather funds. Financing will enable you to have equipment and cash reserves, enabling you to take advantage of these opportunities fully.