Craving a new gadget?
By Gary I. Glassman, CPA
You know the benefits of offering a complete in-house lab. You--and anxious pet owners--can get quick answers on complex cases, and you can begin treatment immediately rather than hospitalizing the patient until you receive test results the next morning. In addition, owning high-tech gadgets lets you practice high-quality medicine.
Admit it--you crave some piece of equipment. What do your colleagues want most? Such high-tech gadgets as computers and anesthesia machines top the list, along with surgical instruments and cages. When asked what equipment Veterinary Economics readers plan to buy in the next 18 months, more than 10 percent of the 1999 respondents listed computers. More doctors want blood pressure and ECG monitors and ultrasound units than ever, and interest in most of the other equipment categories remained steady.
Progressive veterinary hospitals budget 2 percent to 3 percent of their yearly revenue for equipment acquisitions--including replacing outdated machines. If your hospital grosses $500,000 a year, this means you have $15,000 to spend on equipment. So before you buy a new pulse oximeter or a laser surgery unit, make sure the equipment will pay for itself in the long run.
Know before you buy
Equipment purchases need to make sense economically--not just emotionally. For example, say that you want to buy a laser surgery unit. Your veterinary software likely already contains all the information you need to determine whether the equipment will provide an adequate return on your investment. First, investigate the number of times you provide a service that you could improve by using a laser. Then add up all your costs: purchase price and shipping costs; set-up fees; time to obsolescence; cost of training; and operating costs, including supplies, maintenance, upgrades, and payroll.
Next you need to set a fee you'll add to the service cost and estimate the number of times you'll use the laser for these procedures in a year. Setting a fee can be more challenging than it appears. You can ask the equipment salesperson, but his or her answer likely won't take into account your hospital's unique cost structure. And even determining what area hospitals charge may not work if your costs vary. When you set the fee, consider all costs, including the purchase price, training, transaction fees, and profit. You want to see a return on your investment of 20 percent to 25 percent or a payback period of four to five years. If your numbers don't jibe with these industry averages, don't buy the equipment.
The return on investment for a laser surgery unit can be made in a short amount of time. However, positive numbers alone don't indicate you should buy a piece of equipment. Ask yourself these questions: How will the machine improve my practice's quality of medicine? Will the equipment enhance practice efficiency?
Then talk with employees and associates to ensure they agree with your decision. If staff members don't support your acquisition, you won't use the equipment to its full advantage because your team members won't promote the service to clients as well.
To maximize the benefit of a new purchase and enlist staff members' support, educate all employees about the importance of the purchase. For those who will use the new equipment regularly, provide the training they need to use the equipment properly. If associates or support team members show a special interest in the equipment, ask them to train others.
Finding the money
After you've decided to buy, you must decide whether to finance your purchase by paying cash, taking a bank loan, or leasing the equipment.
Paying cash. If using cash will create other financial hardships--including delaying normal vendor payments--try financing or leasing instead. Also consider the tax ramifications of paying cash. Equipment purchases are eligible for the Internal Revenue Service (IRS) Section 179 deduction. This lets you deduct the first $20,000 of equipment purchases in 2000 from your taxable income. If equipment purchases exceed this amount, you could be giving up cash without generating an immediate tax deduction. You must depreciate the balance of purchases that exceed $20,000 over five to seven years. So if you spend all your cash on the purchase and then owe taxes, you could find yourself borrowing additional funds to pay taxes.
Bank financing. Bank financing preserves cash, and you get the same tax deductions as if you'd paid cash. Banks usually require a 10 percent to 20 percent down payment and structure repayments over three to five years. Watch loan agreements for floating market interest rates that are related to the prime lending rate. With the current interest-rate volatility, rates could soar, making your equipment purchase that much more expensive. That's why now may be a good time to consider fixed-rate financing.
When reviewing the loan, keep an eye open for collateral assignments, where the bank takes a security interest in the equipment financed. Try to avoid situations where the bank takes other assets in addition to the equipment financed as security for the loan. Also watch for financial covenants in loan documents requiring specific financial performance, such as a certain level of profit, to keep your loan from default.
If you're equipping a new hospital and can't get traditional financing, consider a Small Business Administration (SBA) loan. You may pay higher rates and fees, but often the SBA will stretch payments over seven years, making your monthly expenditure more manageable.
Leasing. Equipment vendors offer this popular option for convenience. Choose leasing when you're concerned about cash flow and can't afford a down payment. Also select this option when the monthly payment write-off is significantly quicker than depreciation write-offs. One caution: Make sure the lease is written in the practice's name, and beware of how you sign. Don't give a personal guarantee as part of the lease terms. You don't want to be personally liable if the practice defaults on payments.
Finally, keep in mind that leasing companies are usually outside companies that only provide the financing. If you have a problem with the equipment or vendor, the leasing company may not want to get involved.
The biggest decision you'll make about the lease is what kind of buyout plan you want. You'll pick from three options. Some leases offer a $1 buyout. If you know you want to own the equipment when the lease ends, this option offers the smallest out-of-pocket costs. The monthly payments are generally higher, and for accounting and tax purposes you'll treat payments as if you bought the equipment at the outset. You depreciate the equipment over the IRS statutory depreciation life, and you can take a Section 179 deduction.
Or you could pick a lease with a 10 percent buy-out option. You'll pay 10 percent of the purchase price at the end of the lease term, and you can deduct the lease payment over the lease period.
If you don't plan to own the equipment when the lease ends, consider a fair-market-value lease. These usually last three years and require the lowest monthly payments, which you'll treat as operating leases for accounting and tax purposes. This means you can deduct payments over the life of the lease, but you can't take the IRS code Section 179 deduction. This type of lease works best when you're buying high-tech equipment that will soon be obsolete. If you decide at the end of the lease that you want to own the equipment, the leasing company will set the payoff option at what it considers to be the fair-market value. Sometimes you can negotiate this amount.
Before signing any lease, first negotiate the purchase price. Also ask about property and sales taxes. Finally, determine the imputed interest rate by running the terms through a standard loan amortization software program. You may discover that interest totals 12 percent to 16 percent of the purchase price. A rate of 9.5 percent to 10.5 percent is more reasonable.
If the imputed interest is too high, consider other options. Falling for the salesperson's pitch of "No money down and only 60 payments of $299" without knowing the total price--with interest--can put a deep dent in your long-term equipment budget.
As more people recognize the importance of the human-animal bond, veterinary medicine and its tools grow more sophisticated. And bonded clients will pay for high-level care. But make sure your equipment purchases make financial sense before you sign on the dotted line.
Gary I. Glassman, CPA, a Veterinary Economics Editorial Advisory Board member, is a partner with Burzenski & Co. PC in East Haven, Conn., and specializes in accounting and tax planning for veterinary hospitals and owners. You can reach him at (203) 468-8133 or email@example.com.
Special Edition 2000 Veterinary Economics