How the use of debt can create success in the lab

June 23, 2017 News

by Bruce Bryen, CPA, CVA

 

What good is debt? Why use it for one’s business?  

In explanations to owners of dental labs about the use of debt, there are typically two thought processes that take place in the discussion. One concept is that if the acquisition of an expensive piece of equipment can not be paid for now, it is not appropriate to purchase it since borrowing money is not a good idea.  A business person who wants his or her enterprise to grow knows that there is a difference between good debt and bad debt.  Borrowing when the use of that debt makes no sense is a mistake and it should not be done.  A trip to the Caribbean with the family paid by credit card likely will not be used for the growth of the lab. Going to a lender and requesting funds to buy or lease sophisticated equipment that increases productivity and brings more positive cash flow to the lab is a smart choice.  Allowing a lab to increase its worth is a good example of the use of debt for success.  Let’s see some examples of why the idea about borrowing does make sense and can create a dental lab worth emulating. 

The following gives examples of debt and its use for profit and growth.  

When a dentist contracts with a lab, he or she assumes that the finished product is one of quality and competitive pricing. The difference with many labs and why dentists prefer one over another may be the service and speed in which that product is returned to the dentist.  The following is an example of the use of debt with the hypothetical purchase of a sophisticated piece of equipment with a price of $100,000.  Based on the format of the enterprise in which the lab was originated, such as an LLC, the lab can take a tax deduction of $100,000 now. Using the current year and borrowing the funds through the LLC, the lab receives a $100,000 tax deduction against its income for 2017.  Of course the lender will insist on a personal guarantee as almost all lenders do when lending to small businesses with few owners and a thin capital base.  If the lab owner can negotiate a loan over a seven year term, the LLC will be paying about $1500 per month including competitive interest rates.  Assuming a tax rate of 50% including federal, state, social security and medi-care (both halves for the owner), the owner saves $50,000 immediately in tax. At $1500 per month for the debt servicing, the owner has the use of the tax savings of $50,000 on a declining basis of $1500 per month for almost 2.5 years.  Besides the increased production, speed and tax savings, the lab owner will probably have more satisfied customers because of the much quicker turn around time provided to the dentists. This potential exists since production time will become available with the use of the equipment lessening the need for labor costs.

Tax benefits, increase in cash flow and much better service created by debt.  

The previous paragraph explains many of the benefits available to the lab owner including the important concept of tax savings that automatically increase cash flow. There is another important benefit as well. Many of the larger labs borrow more easily than the smaller lab and have done so to increase their customer base. The dentists enjoy the benefit of better service. This also allows the lab to add more of the dental profession to their base of customers since the acquisition of the equipment increases the speed of their production.   If the smaller lab recognizes the benefit of borrowing when the outcome of that debt is to enhance the business of the lab, it too will have an expanded income, greater cash flow and growth in value.  Since there are many benefits and various aspects to be discussed, it is important that the lab owner has a good team of professional advisors to explain why the use of debt can be a benefit.  Sometimes the small lab owner becomes friendly enough with some of the dental customers that are serviced that a referral can be requested of the dental CPA that the dentist retains for advice.  This is an advantage if the lab owner does not have a reliable advisor who understands taxes, cash flow and the use of the present value of money.

Other benefits obtained by the use of debt.  

This discussion has centered on the use of debt to acquire equipment. There is also the idea of using debt to fund retirement benefits for the lab owner.  A common occurrence is that a tax is due and it has not been accounted for with proper planning.  A retirement plan contribution that can be paid after the year has ended and is credited towards the previous year is an economic approach to resolve this issue.  The retirement plan contribution is due prior to the filing of the tax return. An automatic extension of time will allow up to eight and one half additional months for paying the contribution and getting the retro active deduction.  This concept reduces the current tax and allows money to be saved for retirement without tax on its income until the funds are withdrawn.

The lab owner and debt for success when properly managed:  

This treatise relates to how the use of debt can create a substantial positive cash flow for the lab owner and the lab. When contemplating the acquisition of equipment, the implementation and funding of a retirement plan or even a long or short term lease, “good,” debt is preferable to taking funds out of the operations of the lab that should be use for current overhead.  Matching income with the expense that creates that income is a profitable approach.  If the equipment is going to last more than one year, it should not be paid for in one year.  If that happens, the year in which payment is made has its income suffer and the period of time when the equipment continues to be productive has no offsetting expense to match against it.