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Flexible financing for more flexible production

05 February 2018

Roy Royer offers a possible funding solution which would allow food processors to deploy automation in their processes, giving the flexibility to be more competitive. 

Building the right go-to-market model and having the budget to achieve sustainable profitability starts with a recognition of the financial issues facing your company. We are living in interesting times, with Brexit on the macro-economic level and increasingly more demanding consumers creating a host of business challenges for the food industry.

Banks are under an unprecedented amount of pressure to meet capital adequacy and other balance sheet requirements—making it harder to deploy capital. As capital slows, food industry growth plans often follow.

Unfortunately, there will always be a level of uncertainty, but this should never become an excuse to live with mediocrity.

Forcing too much lending into the bank may limit growth potential. A simple diversification approach – letting real-estate lenders handle real estate, equipment-driven lenders handle equipment and the banks handle the working capital – could create opportunity. Diversification can lead to greater access to more flexible capital when you need it most.

New product lines or production capacity growth requires capital investment in depreciating assets. While equipment loans help solve the upfront cash requirements of capital investment, it brings its own set of challenges. While loans provide an affordable and cash-flow friendly path to equipment ownership, it is not a great solution for flexibility. At the end of the loan term, you will still have 100% equity in assets which will be valued at a much lower price than you originally paid for them. Additionally, if the contract term ends or changes you will still own the equipment.

An interesting alternative?
Rental and leasing are an interesting alternative to meet the capital requirements of the food industry. These solutions, when structured well, allow for minimal up-front cash investment and monthly payments to fit into a budget that can be matched to other expenses and revenues associated with the contract. Additionally, rental and leasing offer the ability to return the equipment at the end of term and in some cases, before the end of term. This flexibility adheres to a ‘pay for use’ mentality, as opposed to an ownership mentality.

Food retailers rely on contract manufacturers to be increasingly nimble and adaptable to meet fast-changing consumer demands. But, with British food companies lagging behind in the adoption of automation, combined with the trend for short-term production contracts, food producers are often anything but adaptable.

With contract terms as short as 18 months how can companies affordably equip themselves for more flexible and efficient production without a huge capital outlay and significant end of contract risk?

These capital risks and budget concerns often limit growth plans or the ability to bid competitively. To solve this, food manufacturers need to look at the alternatives that could help limit end of contract risk, while still obtaining the equipment they need, with the knowledge that they can turn in the equipment should the contract end, or keep the equipment if the production contract renews. With a simple monthly payment, a flexible rental agreement could make budgeting more predictable. The ability to afford new technology also increases, allowing the business to become more versatile.

With the short-term nature of food production and distribution agreements, financial managers often find it difficult to match cash outflows with inflows. It can take a minimum of six months to achieve the cash flow benefits of a production agreement to achieve a return on investment. This gap can create a cash drain that impacts the whole company.

In contrast, a rental or lease payment will allow income and expenses to be more easily matched. A good solution should allow you to limit the up-front cash impact, with simple monthly payments allowing for ‘ramping up’ of expenses into a new contract affordably while allowing more time to generate the revenues to show profitability sooner. Finally, having the end-of-contract flexibility to turn in the equipment or simple renew if the contract continues beyond the original short-term agreement, offers the ability bring in new business affordably. It also provides the scalability to meet fast-changing customer and consumer demands.

Roy Royer is head of business development at Somerset Equipment Finance.

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