Investing in Capital Expenditures

Steve Mullinger, Senior Vice President of Commercial Banking Market Manager, US Bank

Over the past five years, business owners have become more optimistic about the economy.

In 2018, only 11 percent of business owners said economic uncertainty was their top concern (down from 26 percent in 2014), according to the most recent U.S. Bank Small Business Survey. This owner optimism, plus high consumer confidence, could mean increased consumer purchases.

That means this may be the right time to consider capital expenditures—buying or maintaining fixed assets such as equipment, buildings or property—to move your business forward. Different from operational expenses that are purchased and used in the same tax year, capital investments should benefit your business for many years to come.

Capital expenditures can be a good option for expanding, but there are key considerations and discussions to have during each phase of the process.

A business expansion plan: Meet with business partners and key stakeholders early on to discuss the overall objectives and outline what types of capital investments are needed. A plan should include not only the business’s current state (facilities, product lines, number of employees, etc.), but also describe the proposed expansion in detail:

• Equipment or technology upgrades
• New infrastructure or property
• Expansion-related costs
• Projected profits
• New product lines or customer bases

This document will not only ensure all stakeholders are on the same page, but it will also help if you seek out a business loan to help fund an expansion. 

Each asset’s long-term profitability: Compare a capital expenditure’s return on investment against the cost of financing it. An ROI that’s greater than the required financing adds value to your business. Calculate the weighted average cost of capital (WACC) with the help of an advisor or CPA, who can assess an organization’s current debt and equity to determine if investment in new assets will be profitable compared with its financing.

An expansion budget: A separate capital expenditures budget can make the investment’s ROI clearer and streamlines tax reporting. In the tax year after a capital expenditure purchase is made, the asset is accounted for on the organization’s income statement and factored in as asset depreciation, which is spread over the expected life of the asset.

Leasing as an option: You also may want to consider whether it’s better to lease or own – especially when purchasing equipment that could quickly become obsolete (such as computers). 

Tax implications: Because capital expenditures are considered investments, they are assessed differently than operational expenses for tax purposes. Asset yearly depreciation is tax- deductible and the assets cost will likely pay for itself over the course of its life.

Choosing a loan type: Term loans can be short- or long-term loans used to finance larger purchases. Most term loans are set to a specified amount and can have payment terms up to 80 months, depending on the type of loan. Small Business Administration (SBA) small business loans are low-interest loans issued by banks and backed by the SBA. SBA-backed loans can be an attractive option because of their favorable interest-rate and repayment terms. However, it is a time-consuming loan application process with strict guidelines.

Preparing for a loan: Lenders look at your business’s credit history, current business debts and assets and cash flow. A lender will also want to review tax returns and financial documents to gauge the overall health of the business. Be prepared to answer questions about your business’s debt-to-income ratio as well as earnings before interest, taxes, depreciation and amortization (EBITDA). Also, be ready to provide the expansion plan that outlines your strategy for growth.

Questions to ask your lender:

• What are the loan’s minimum requirements? By asking this early on, you’ll make sure your business qualifies for the loans.
• How long does it take to process the loan? Seeking a loan early in the expansion process can give you more breathing room if a loan takes time.
• What are the interest rates and fees? This impacts the overall cost of the loan throughout its duration.
• Is collateral required? You’ll want to find out what’s expected in lieu of payment if you can’t repay the loan in full.
  

Taking a business to the next level can be an intensive but exciting process. By taking the time to plan out each stage of a capital expenditure, from developing an expansion plan, to meeting with lenders and communicating to stakeholders, the journey can move along much more smoothly.