Laboratory Expansion and Methods to Finance It
Keep taxes in mind when investing
Bruce Bryen, CPA, CVA
Any laboratory owner interested in expanding his or her business must think carefully about which method of funding to use in order to gain the maximum tax, financial, and competitive advantage. Some of the ideas include using the laboratory's working capital, borrowing on a short- or long-term basis, contributing the owner's own capital to the laboratory, or a combination of some or all of these methods. The following paragraphs outline some of the advantages and disadvantages of each concept according to accountants who work with dental laboratories. These could help laboratory owners make more informed choices for their situation and plan for the future based on those decisions.
Using the Laboratory's Working Capital
For those not inclined to borrow, using the laboratory's working capital to finance the business's expansion will save large amounts of interest. On an economic basis, it may be one of the cheapest ways to expand. One drawback is the stress caused by the ups and downs that every business faces with cash flow throughout year. This may also create a lag in the project completion time and set off other revenue and expense repercussions. Another point of concern may be the lack of available funds for other important areas that appear during the normal laboratory business cycle; this includes payroll, owner draw, and any unusual or unforeseen expenses. The write-off is available whether the expansion is financed or paid for with the cash flow of the laboratory. Some advisors will suggest thinking about the present value of the tax write-off without tying up the laboratory's cash flow.
Borrowing for the Expansion Plans
Financing is available to maximize the owner's business benefit without jeopardizing the business operating account. Proponents of borrowing use this advice to enhance the cash flow of the laboratory. They suggest taking advantage of the tax deduction's present value and keeping the flow of operating funds readily available. With a lender's funds, the project will almost always finish much faster. Since the funds are coming from the bank, the contractor will know that money will be available as certain percentages of the project are finished. This eases the pressure of cash flow since the laboratory's business can continue with no need to use the gross revenue from the short term for the long-term nature of the expansion. It is good business to match up the need and cost of a project with the time that the result of the construction and equipment acquisition will continue to be available. For example, one does not buy a house with a 5-year mortgage; it is typical for a house to have a mortgage over a longer term, such as 20 to 30 years, because the economic reality is that the house will last at least that long.
Borrowing for Short, Medium, or Long Term
Is the laboratory owner more concerned about cash flow, interest rates, or how quickly he or she can pay off the loan? From a cash flow standpoint, the longest term available at a reasonable interest rate will require the lowest monthly payment. One may be surprised at how the interest rate variation between a 10-year loan and a 5-year loan changes the monthly payment. When financing real estate improvements, terms that are lengthier than equipment loan terms offer a lower amount of monthly payment than the equipment financing time line. The interest rate is normally higher based on the length of time requested to pay back the loan. The difference in monthly cash payment with the longer term compared to those that are shorter is substantially less than the shorter-term loan with the lower interest rate. At that point, what is the most important factor when determining the type of loan to acquire? Looking at a rate differential, one will probably find a difference of about 0.5% more with the longer amount of time attached to the loan terms. The longer-term loan most increases the amount of the total payments since there are more years of payment required. There is still a tax benefit to interest paid by a business, so the rate differential with the longer loan term is realistically less onerous as well.
Investing Owner's Capital into Expansion
An owner investing their personal capital is a more complicated matter. The owner will want to know what type of a return he or she is receiving on the funds now. That rate of return would be compared to the laboratory's predicted return, which should translate into a better long-term profit to the owner. The return may be on the basis of a potential sale, the savings to the laboratory now in interest costs, or the unrecorded profit to the owner and laboratory based on its ongoing ability to serve customers and increase business. Does this enhance the balance sheet of the enterprise and allow further expansion or acquisition opportunities with additional invested capital? What is the owner looking for from the business over the long term, and how will the present decision affect it while the owner is still involved?
No high-dollar decisions are easy. Financial advisors should be consulted for a decision that determines the future for the owner and the laboratory. This takes time, but it is worthwhile to spend the extra time considering which approach to take and the ramifications involved with each.
About the Author
Bruce Bryen is the principal in the firm of RKG Tax and Business Services, LLC, in Fort Washington, Pennsylvania.