Construction Best Practices: Are You Equipped to Forecast Your Equipment Needs?
This article first appeared in the Construction Best Practices.
Year-over-year revenue can experience large swings as even a single project won or lost can significantly impact revenue. As such, it is extremely important to understand your company’s past, present and future revenue estimates when considering your equipment fleet profile. It is part and parcel of the overall strategic growth of your business and one of the areas where many contractors get into trouble.
If managing the size, mix and utilization of the fleet is not properly planned during incremental growth stages, equipment can become a fixed cost that negatively impacts the business — particularly in a slowdown. Sticking with a well-defined and controlled growth strategy can ultimately make the difference in your businesses’ success — or failure.
Does your company’s equipment acquisition strategy take into account what projects have been awarded and which are on the horizon? Which projects or clients are sustainable? What work is consistent year in and year out? What equipment is affordable and survives a cost-benefit analysis?
Being a contractor means that you have to be nimble and willing to flex your craft labor and equipment fleets, as required. Balancing the mix between owning, leasing or renting equipment is an important component to keeping your business viable in times of growth or contraction. Having a mix of all three is often the best solution.
Owning, leasing or renting equipment all impact your project differently. Some contractors plan for higher input costs on a job to have the flexibility of a short-term rental or medium-term lease. Other contractors spend cash upfront to purchase and then run owned equipment into the ground. Cost-effective equipment ownership means that you’ve held onto your backhoe long enough for full depreciation.
Additionally, your fleet can keep working past financing terms, which can result in less input costs on a project and lower bidding when quoting. There are even some companies that want to own all of their equipment for the purpose of making their EBITDA look more attractive to private equity and other entities sizing a company for potential acquisition.
The correct equipment mix should be part of your masterplan. Too often, companies overlook sizing for a base level of work. As a result, needs are often sized for an ideal workload or current performance without a consideration of the longer-term cyclicality of the business. Contractors typically sit in two different camps: Wants to (A) own everything or (B) own very little.
Successful contractors understand their base of work and the need to have a flexible fleet of equipment. You obviously do not want to have to pay on equipment if it’s not making the company money. Renting equipment is more expensive but can make sense for short-term operational needs. Renting also means having fewer resources to maintain and repair than owned and leased equipment. Leasing is more of the middle-of-the-road approach and suitable for when you plan to cycle equipment on and off on a regular basis and want cost to be reasonable.
The optimal equipment mix is not one size fits all; there isn’t one ideal, blanket percentage mix for owned, leased and rented equipment. Rather, you’ll find the answer that’s right for your company in your strategic plan, sustainable business model and ability to access capital.
Not closely examining these areas can get contractors into tangible trouble: “We had a really good year last year and I’m planning on growing,” or, “We’re going to be at this level next year because the market is good.” How can you be sure without looking at real numbers? Are you willing to risk your business on the if/come?
Your fleet financing
An important benefit of owning equipment is found when seeking additional capital for your business because banks have more of an appetite to lend you money when equipment serves as collateral, as opposed to having a cash flow loan or receivables as collateral. Banks prefer hard assets (equipment) as collateral.
However, a bank’s recovery is at risk in a distress situation. If your bank loan is backed by receivables, you have leverage over the bank as you must finish the project to collect those receivables. If the loan is backed by equipment, that’s the collateral and the bank can sell the equipment right out from under you.
Traditional banks and ABL lenders typically don’t like the volatility and risk of the construction industry. They’re more likely to lend if you already own equipment and are looking to add to your fleet. Lenders will look at your financial performance and specifically your credit worthiness as they consider the viability of regular payments. Those same banks may provide an equipment-based loan, but they’re not going to finance 100 percent of your equipment. Most equipment lenders are going to lend on either an orderly or forced liquidation value, which is probably going to be around 75 to 85 percent value.
A big question is whether to seek financing from a traditional bank or an equipment dealer. A dealer provides equipment loans for the equipment whereas a traditional bank or ABL lender may provide a large term loan where equipment is one piece of the collateral package. A large term loan from a bank will probably carry tighter control over your business because of loan covenants such as leverage targets, fixed charge ratios and minimum EBITDA requirements.
An equipment dealer typically has one requirement: make your monthly payment. So do you pick bigger dollars with tighter requirements or basic equipment financing? It depends on your needs and your leverage profile.
It is also imperative to manage your leverage profile. Even though you have owned equipment and the collateral to support it, you don’t want to be overextended with debt. Some may feel they can pile up the debt, but if the business fluctuates downward and free cash flow shrinks, payments can be an issue. Adapting to fluctuations in the business is one reason why you may want to rent for a period of time — at least until you can reach sustainability.
A strategically managed equipment fleet should be a priority because it can make or break your business. It can define your company’s success when bidding on new work and during the fluctuations common to our industry. You can take that to the bank — and that next job.