Gear Zone: Avoiding the interest rates trap in financing forestry equipment
By Alexis Piette
By Alexis Piette
Canadian forestry, like other natural resources-based industries, is cyclical and dependant on many external factors such as housing starts, trade conflicts, currency fluctuations and larger investments than many other industries. With the lack of labour, the current forest regime, harvesting sectors that are further and further away and the pressure on the entire the supply chain, forestry contractors are no longer simple lumberjacks: they are now expert managers. They must handle all areas of management: human resources, sales (negotiation), administration, management and, of course, operations.
Like a conductor, contractors must lead their musicians in perfect harmony. In terms of finances, the first aspect to consider is the business’ self-generated funds, i.e., the company’s capacity to generate cash flows. The objective is quite simple: to have more money coming into the bank account than going out.
Let’s start by analyzing the largest main cash outflows, which represent, on average, 90 per cent of all of a business’ expenses: wages and benefits, fuel, maintenance/repairs, debt repayments (capital and interests) and insurance. Of those expenses, 70 per cent are directly related to the quality of the equipment, its operation (maintenance and method of use) and its renewal/acquisition. Newer equipment will reduce fuel and maintenance expenses, increase debt repayments and also significantly increase productivity and, as a result, revenues. In addition, you will attract qualified talent by having state-of-the-art and well-maintained equipment. The right combination will depend on a number of factors specific to each contractor’s operation. Finding the right balance is an art and there is a fine line between renewing equipment at the right time and waiting too long to do so, which can end up being costly.
When to renew equipment and which equipment?
Each contractor has to find a system according to their type of operation (day only, night and day, short wood, long wood, the type of terrain, etc.) and their company’s lifecycle. They therefore must find the sweet spot, or the time when savings on maintenance/repairs, the increase in productivity and fuel efficiency are equivalent to the debt repayments. Once this decision has been made, the choice of dealer/manufacturer is critical, and, lastly, the choice of financing partner will need to be made in an effort to increase cash holdings and the organization’s self-generated funds.
Choosing the right partner for your project
Like the choice of when to renew or acquire equipment, choosing the financing structure and financial partner is very important. The two go together. A good financing partner will guide clients regarding optimal financing conditions and the structure. A financial company that specializes in financing equipment and a commercial manager who is trustworthy and specializes in forestry are wise choices, although sometimes your short-term lender is the right one. The specialist in equipment financing will nonetheless be able to optimize the financing structure (both specific to the transaction and overall) while keeping in mind what is best for its operations in the long-term. By diversifying your financing sources by segment (short term, equipment and building financing) partners will be more flexible and able to adapt to the various economic cycles.
Everyone has their own strengths
The account manager responsible for your file is also the representative of your business with its own organization. He or she will be able to defend your interests with transparency. An account manager can also review your entire organizational structure with you. Account managers typically see hundreds of similar files a year and will be able to inform you of the best practices. Well-intentioned account managers (hence the importance of choosing someone trustworthy) will be able to review your entire financial structure and suggest solutions to optimize your company’s profitability and liquidities. Choose your financing partner carefully. They will be more flexible during unforeseen events (forest fires, operations slowdowns, labour strikes) and will be able to find a solution to accommodate you, such as a moratorium or cash injections.
As a specialist in forestry financing, I, unfortunately, too often see contractors choose their financing partner for the acquisition of a new piece of equipment based on easy financing and low interest rates. But that only represents a small part of a business’ expenses compared to maintenance, productivity and a supplier’s ability to properly serve their clients (e.g., large part inventory for breakdowns, an available service team, efficient equipment, etc.).
The interest rate myth
Our world is currently overflowing with organizations offering financing solutions and these offers come from all around when it’s time to finance your new acquisition. Unfortunately, all too often, the one that has the best rate is chosen. Yet, the most important thing for forestry contractors is their ability to generate cash flows and liquidities. Out of your expenses, the interest paid represents on average 1.5 to three per cent. Therefore, a difference of one per cent in an interest rate will have very little effect on your cash outflows. On the other hand, a six-month amortization difference may represent five to 10 times the one per cent difference in interest rate. The same is true for the initial deposit, although it directly affects the company’s working capital. In short, generally, too much importance is given to the interest rate compared to the structure and choosing the right financing partner.
There is no magic bullet when it comes to financing. It’s up to each forestry contractor to choose the right partner for them. However, like choosing equipment or a distributor, choosing a financing partner shouldn’t be based solely on the interest rate, but on the overall financing structure, the adaptability of the financing partner and confidence in the account manager who will provide you with the services.
Alexis Piette is the senior account manager for Mitsubishi HC Capital Canada, Inc.