When it comes to making an expensive equipment purchase, how often are you trusting your gut versus going by solid numbers that back your decision?
Sometimes you may opt not to purchase a machine, assuming it will be underutilized and not make enough money to justify the monthly payments. However, it’s impossible to know this for certain unless you’ve conducted a cost-benefit analysis.
“I’ve had supervisors say a piece of equipment wasn’t worth buying because it would only be used three days a week,” says John Joestgen, principal of JJ Landscape Consulting. “I showed him how the labor savings justified the purchase if the equipment was used as little as five hours per week.”
When to Buy Versus Rent?
Joestgen says a tell-tale sign of when you need to question whether to buy a piece of equipment is if you are regularly renting it and realize you could have bought it for what you were paying in rental fees.
“When you rent ask about a re-capture policy if you were to eventually buy the piece,” he says. “Create a list of any equipment that you are occasionally renting as well as anything that would save time instead of doing it manually.”
Gather quotes for these equipment pieces as well as down payment and payment plan options and compare these to your rental rates.
Joestgen recommends bringing in your foremen, supervisors and production managers to discuss.
“Ask production how many hours would this piece get used in an average week, and how much would it reduce labor hours for the task,” Joestgen says. “Then do your analysis using return on investment, break-even analysis, and cost-benefit analysis.”
Review ROI
Calculating your return on investment measures how much money is gained or lost compared to how much money you put in.
“It answers the question ‘Is this a good use of my money’ or compares options to answer ‘What is the best use of my money’ when determining where to invest?” Joestgen says.
Say, for instance, you have three crews of three employees who install construction and enhancement jobs. You don’t have a compact loader, but you’re considering purchasing one.
In this hypothetical example, the loader costs $48,000. With zero down payment and 48 equal payments of $1,000/month, in four years, the machine would be paid for.
The machine can do the work of three employees using wheelbarrows. With laborers earning $25 per hour, that means:
- $75/hour for three workers
- $25/hour for one operator
“Every hour the machine is used saves $50,” Joestgen says
If the loader is used:
- 4 days per week
- 5 hours per day
- 35 weeks per year
That adds up to 2,800 hours over four years. At $50 in labor savings per hour, that equals $140,000 in total labor savings while the machine itself costs $48,000.
That means $92,000 in net gain.
“ROI is $92,000 net gain divided by $48,000 cost, which comes out to a 192% return over four years,” Joestgen says.
This shows how even moderate usage can result in significant labor savings.
Determine Your Break Even
Joestgen also recommends always conducting a break-even analysis anytime you’re adding on a fixed cost like equipment and need to know the sales volume or hours required to recover that cost or determine how long it will take for the investment to pay back.
“It’s common for an investment to have an upfront cost, but then the investment creates an improvement (benefit), daily, weekly, monthly that result in incremental benefit until some point when the total money put in is recovered (equals) the total money saved from that investment,” he says.
If your team disagrees on how many hours the loader will be used, your break-even analysis will help you determine how much the machine needs to be used to reach that point.
In this case, you would divide the year’s payment total by the amount of money saved per hour by the machine. In this example, 240 hours per year divided by 35 weeks of use to equal 6.9 hours of use per week would allow the equipment to pay for itself.
Conduct a Cost-Benefit Analysis
Lastly, your cost-benefit analysis strives to answer the question of ‘Is it worth it?’ by taking both financial and non-financial items into consideration. While things may make sense from an ROI standpoint, a cost-benefit analysis allows you to look at the overall big picture.
Joestgen says this is similar to creating a T-chart of the pros and cons. Think through factors such as risk, safety, quality and customer impact.
In the compact loader decision, take into account elements such as how the operator will be trained, if your mechanic is prepared to take on the maintenance, and if parts are readily available.
“Crews will have reduced fatigue and maybe fewer back injuries,” Joestgen says. “Do the two laborers no longer wheelbarrowing have other productive work they can do? Does efficiency increase daily revenue and gross margin?”
When you take the time to think through equipment purchases from a financial lens rather than on a whim, you can ensure you are adding tools that will ultimately boost productivity and your bottom line.
