Right on the money

Whether you view the current economic situation as a continuing downturn or a fragile recovery, one thing is clear: investment has been delayed and many manufacturers are now in the sixth year of a four-year replacement cycle for their machinery. Why? Mainly, it seems, because they are hoarding up cash in tough times, while SMEs simply may not know how best to get the finance they lack. Large and small alike are making do with the kit they have. This matters, says Alexander Baldock, managing director of Lombard, Royal Bank of Scotland's asset finance division. "Obsolescence beckons ever faster for modern kit. As equipment becomes more out of date and technology moves on, manufacturers become more unproductive and cannot innovate at anywhere near the level needed. In Britain, we cannot compete on the basis of low-cost manufacturing, but rather through innovation and productivity. If this failure to invest continues, we run the real risk of a permanent loss of competitiveness in the UK." This is no remote threat, he argues. Research released by Lombard suggests that 40% of firms have had to turn down new orders, for want of the new equipment they need. "This is costing UK plc £2.3 billion a year at a conservative estimate," states Baldock. "Outdated machinery costs firms, too. What they think they are saving by running that kit into the ground is completely overshadowed by higher maintenance costs, the decline in reliability of the equipment, as well as downtime costs, so they start to wonder if there is any saving at all." Why this lack of investment? One reason is that many businesses see capital expenditure as a major cash commitment. Lombard's findings show that, of the firms investing today, almost half use cash. "Many firms considering investment don't want to use up precious cash, as that might generate cash flow problems later on, or they're setting aside cash for other uses, such as R&D." Asset finance, insists Baldock, is a smarter way to fund assets, with no major upfront costs and the loan secured against the equipment purchased. "The likes of hire purchase, asset-secured debt and leasing provide a flexible and committed line of funding, tailored specifically to a business's needs and an asset's earning power. Manufacturers pay only for the kit while it is earning money for them and only during its useful life, with the lender effectively taking the risk as to what that asset will be worth at the end. That way, asset finance can reduce the cost and risk of owning kit, and power growth." Weighting the options As Richard Carter, head of equipment finance, HSBC, points out, any manufacturer wants to be able to maintain its assets at a level that is appropriate for the business. "The challenge, however, is what are the business opportunities for their products? Companies have been worried about the state of the market and the future of the euro, so putting money into new assets is a concern. But you could well be storing up even bigger problems, if you are burning up your existing assets over several years, with breakdowns and mounting costs." HSBC's approach with asset finance is to base this on a five-year transaction, with fixed or variable interest rates. "But the investment at the outset is relatively low and it is totally discrete from any other funding, such as overdrafts, so it doesn't threaten their cash flow, if and when other financial needs arise. Also, an overdraft is discretionary and can be withdrawn." Carter makes no secret of the fact that not everyone can take this route. "We do this as an important part of funding – for the right customer, with the right asset." Funding tends to be up around the £100,000 level for an asset as well, with the business's cash flow generation and the quality of the asset being considered. "Is it a prototype, highly original, restrictive? Or does it have an established profile, such as CNC machinery from a well known company? After all, it has to be in everyone's interest to have a portfolio of solid assets." Sector-specific solution That, says Steve Chessman, HP & leasing division, Lloyds TSB Commercial Finance, is why asset finance has always played a large part in manufacturing. "It's been an invaluable source for engineering companies, looking to expand their factory operations. One recent customer of Lloyds Bank, for example – a manufacturer of brackets for car engines – was able to borrow £500,000 over five years for this purpose. Asset finance lends itself well to those types of assets that will generate cash, as they are seen as more secure. They can spread the cost of the asset over its useful working life and not out of cash flow or an overdraft." Yet Lombard's Baldock points to research where 72% of businesses questioned still did not know how asset finance works. Why is that? "It's a well understood form of lending when it comes to vans and trucks, for example, but we in the asset finance industry must do a better job of building awareness when it comes to the funding of manufacturing plant," he accepts. But isn't asset finance for the 'big boys'? "It's true that some financiers have pulled out of funding SMEs, but at Lombard are fully committed to them. In fact, while we do approve transactions that are worth hundreds of millions at a time, we also fund purchases down to £5,000 at a time. After all, SMEs are the heartbeat of the economy." High finance "With a substantial percentage of manufacturing companies utilising asset finance as an option, it is clearly a very appropriate instrument for raising capital that suits the sector profile well," says Mark Lee (left), head of manufacturing, transport and logistics at Barclays. One such long-standing relationship is with a manufacturer operating in the high-tech space. "They operate several very sophisticated, multi-million pound machining centres, producing bespoke components for the aviation and high-end automotive sectors. They were looking for Barclays to fund new investment and decided, in discussion with us, that asset finance was the best option. "What confirmed this was the available term of the loan and pricing, as well as the ability to cover any foreign exchange risk associated with the purchase. This is commonplace, as often machinery that manufacturers are seeking to purchase may not be sourced from the UK." Asset finance can also prove attractive to manufacturers where the lease or loan period (and therefore risk) is slightly longer – eg, five years. "Many manufacturers may not want to tie up large amounts of capital over that amount of time," says Alastair Tyler, head of strategic asset finance at Barclays. "What if the opportunity for the acquisition of another company came along during that timeframe, for example? When it comes to the pocket or asset finance, the latter tends to be seen as the best solution."