The Risks of Commercial Equipment Financing

The Risks of Commercial Equipment Financing

Commercial equipment financing allows you to purchase necessary supplies for your business and pay off the sum you owe over time. Most businesses finance at least a portion of their start up or expansion costs. Once you purchase your equipment, the goal is to use profits you earn off its use to pay off the cost of purchasing it. Because you are taking out the loan based on estimated future earnings, there are always some risks involved.

Loan Default

The biggest risk any time you take out a loan is loan default. When you default on a commercial equipment loan, your business's credit score will drop. Your personal credit may also be affected if you used your own information to apply for the loan. Even greater than the risk of credit problems, though, is the fact your asset may be seized. Many equipment loans are secured against collateral, typically the equipment itself. For example, you may secure the purchase of a tractor for a landscaping business with the tractor itself. If you default on the loan, you may be right in the middle of using the equipment for a job when it is seized. You will lose the ability to use the asset and also lose any money you already paid toward its purchase.

Too Much Debt

Businesses, like households, need to be wary of how much debt they take on. Your business will likely operate on a cycle of debt. This means you will pay employee salaries, rent and make other necessary payments using credit. Then, you will pay off those loans with the profits you earn in the short future. While this generally works well, some businesses do not appropriately control their debt. As a result, their profits cannot cover the debt they have incurred. This will lead to business bankruptcy.

Equipment Loses Value

Buying equipment is a lot like buying a car. Over time, the equipment will lose value. Even after one use, the value of a piece of equipment usually goes down tremendously. This is especially true with high-tech equipment; technology changes very rapidly, and it will quickly become outdated. When this happens, you will end up with an asset worth much less than you paid for it once the loan is paid off. To assure against this problem, opt for shorter loans. You may also consider choosing a mix of financing and leasing for your more expensive equipment. 

Leasing is Cheaper

There are times when a lease will ultimately be less expensive than purchasing a machine out right. Remember: when you lease something, you are simply giving the money away instead of building an asset. At the end of a lease, you will have nothing to show for all of your payments. However, leasing can still make sense in some situations. If you need the equipment very rarely, consider leasing it. If you think the equipment will drop in value by the time you pay off a loan, consider leasing this equipment as well. Build assets where you can, and use leases where it makes more sense financially.


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