21 May The Equipment Finance Fallacy
Let the truth be told. A magician is the master of the dark arts of manipulation, misdirection and deception. On the best part for entertainment. Not to say though in controversial circles that these skills are put the test in the commercial market.
As Bernie Shine states “There is a thin line between reality and illusion, and every great trick has a flaw. The magician’s task is to minimize, disguise, or justify the flaw… The very tool that is supposed to prevent trickery enables it.”
Nothing is truer than the financiers of plant and equipment throwing an anchor in the market screaming LOW Interest Rates for their equipment finance, when in fact this is far from the truth.
Behavioural bias of the human mind will gravitate to an anchor of a long-held belief to govern a decision. We have been conditioned through a lifetime of experience that the interest rate of a loan is the true cost of capital. And so it is in its purest undiluted form.
But allow us to break it down to demonstrate that world of finance is not so pure and trickery of the mind is at large.
When you receive an equipment finance contract, do you ever see the interest rate being quoted? Most likely not when a commitment schedule is being provided.
You may have been quoted an interest rate at inception “as a quote” which may also include a commitment payment schedule. If you had the calculative capability and back tested the quote, you may find that the advertised yield does not match up with the commitment.
An equipment finance contract will indeed imbed a yield within its calculations, but what has been misdirected is the “effective yield” or the real cost of capital being charged.
Through the process, the commitment schedule being provided also imbeds “other” fees and charges to ensure the financier receives a yield they seek for the funding.
For the borrower, the misconception is the interest rate being paid versus the effective yield. For most borrowers (on the mass), they have little time, skill or knowledge as to what the rate being paid really is.
Even if several quotes have been obtained, very rarely are they “like with like”. Any slight variation in the parameters of the quote (timing of payments, date of quote, tenure, GST repayments, balloons etc) will materially distort the outcome.
Borrowers seeking equipment finance are merely spectators in a glitzy Los Vegas Siegfried and Roy magical side show. To smash through the spectacle and blow open the fallacy, I recommend the following;
- Tender your requirements on a template to ensure all the parameters being requested remain status quo.
- Seek responses on the same day.
- Back test the commitments against the quote to validate the offer (and to also determine the disclosure credibility of the financier).
- Check the fine print for the calculation of break costs. Very rarely does plant and equipment useful life exactly match that of the contract.
- Pre-establish what the commitment of the contract will have on your Debt Servicing Commitment Ratio and Equity on your business, and benchmark this against your underlying bank’s ratio thresholds. How will impact your credit profile and future fundability? Perhaps different structures will need to be considered.