When we acquire a piece of packaging equipment, we do so because it will help us make more money. The purchase of a stretch wrapper, for example, will result in lower labor costs, decrease material usage, and better secure our products during the shipping process. The purchase of an automatic bagger will increase revenue by scaling up production. In both scenarios – lower costs and higher revenues – we see a significant increase our company’s cash flow.
Let’s say we spend $45,000 on a flow wrapper, and that flow wrapper increases our cash flow by $15,000 a year. It will take three years for us to recoup the initial $45,000 investment. Those three years are the payback period. Until the three years are up, we’re missing out on the use of that $45,000. It’s only after the three years have gone by that we begin to see a positive return on the purchase.
Now, let’s say that we decide to lease the flow wrapper instead of purchasing it outright. We set up a five-year lease with a 10% purchase option. The lease payments come to $830 per month. The increase in our cash flow was $15,000 per year, which comes to $1,250 per month. $1,250 minus $830 gives us $420 per month in profit, and we get that profit now, not in three years’ time.
This doesn’t just preserve our working capital, it outright expands it. The original $45,000 is still available in our capital budget, and now we’re making an extra $420 per month. By avoiding the initial cash outflow, we’re able to keep our company financially healthy and make a little money on the way.
The 10% purchase option is commonly chosen by our customers because it reduces monthly payments, which increases the profit they get each month. A 10% purchase option allows you to purchase the equipment for 10% of the original cost at the end of the lease term. American Packaging Capital also offers a $1 purchase option. Many customers like this purchase option for its simplicity, although our 10% and FMV purchase options create better cash flow. FMV leases are even better for cash flow than 10% leases, but they’re also less predictable. Speak to your accounting professional to determine the best option for your company.
Sophisticated capital budgeting is key to growing a manufacturing business. By using the zero payback period technique, you can help keep your company profitable and strong.