Here are three important steps to reduce that downside risk:
- Calculate and analyze the return-on-investment (ROI) before putting down any money on the lease or purchase of major equipment.
- Focus investments on the types of equipment that are most likely to deliver steady returns for the work you do, and avoid investing in equipment that’s expensive to operate and maintain, or which will spend a lot of time sitting idle.
- Make a plan to ensure the promised ROI comes true.
Calculating ROI
ROI is the simple concept of estimating how much an investment will contribute to a business. Most equipment dealers will provide you with a generic ROI for any given piece of machinery – based on some broad-based assumptions that may or may not apply to your specific business. They’ll say something like, “This machine is capable of delivering 40% ROI over five years.”
It sounds good, but what exactly does that mean?
In short, that claim means that for every $1,000 you spend to buy a particular piece of equipment, it will add $1,400 of revenue – covering its own expenses plus another $400 of profit over a five-year period.
In real life, the percentage and the time frame will vary from one investment to the next, based on the specific piece of equipment and the financial terms. Further, ROI calculations are just estimates; the more realistic the assumptions that go into a calculation, the more useful the ROI estimate will be.
Here’s the information required to make a realistic ROI calculation, according to Finance Scope, which provides construction equipment financing services. It works whether you lease or buy.
- Expected Equipment Lifetime: Any equipment dealer is likely to have a pretty good rule of thumb for how long a particular piece of equipment will last. Or you can estimate it based on your own experience, industry standards, historical data or even asking an AI chatbot. (If you’re leasing, the expected lifetime is the length of the lease.)
- Initial Investment: Includes the purchase price, taxes, delivery fees and all interest and other fees to be paid on the loan. (If leasing, it’s all costs paid to the leasing company over the term of the lease.)
- Operating Expenses: Your best estimate on fuel, regular maintenance, repairs, insurance and storage over the lifetime of the equipment. Dealers should be able to rattle off averages for this kind of information, which you can adapt based on knowledge of your own operations. (If leasing, it’s the total spent on these items over the term of the lease.)
- Total Cost: Equal to the Initial Investment + Operating Expenses.
- Revenue Generated: Your best estimate of how much extra money you’ll bring in or save due to improved efficiency and/or new capabilities. This is estimated over the lifetime of the equipment or the term of the lease. This is the most difficult factor to project, and it’s where ROI estimates are most likely to go off the rails. So be conservative; if your revenue projections are unrealistic, so is your final ROI calculation.
- Net profit: Equal to Revenue Generated – Total Cost.
Once you have this information, here’s the formula for ROI:
- (Net Profit/Initial Investment) × 100 = ROI
Here’s a simple example for a skid-steer, from the blog of Texas Final Drive, a supplier of final drive motors:
- Expected lifetime: 5,000-7,000 operating hours if properly maintained, according to Wickham Tractor Co. – or about five years, assuming 20 hours of use per week
- Initial investment: $50,000
- Estimated operating expense: $4,000/year over five years, or $20,000 total
- Total cost: $70,000
- Revenue generated: $20,000/year over five years, or $100,000 total
- Net profit: $30,000
ROI = ($30,000/$50,000) x 100 = 60%
Some types of equipment are easier to cost-justify than others. The more a machine costs, the higher utilization you’ll need to achieve healthy ROI.
The ROI relationship between cost and utilization
Any type of construction equipment comes in a variety of sizes. Larger equipment can handle more material, but smaller equipment can perform in tighter spaces. The key to maximizing ROI, according Warren CAT, is to balance these two conflicting variables. If it’s too small, the big jobs will take longer. If it’s too big, you’ll have to rent equipment for the smaller jobs while your own machine sits idle in the yard – taking up space and restricting the cash flow construction businesses need to pay for labor and supplies.
Skid-steers and track loaders are ROI champions. They’re useful on just about any job of any size, and the variety of available attachments allows them to serve multiple functions.
Mini or Compact Excavators are another reliable ROI hero, according to Mechmaxx. Their range of capabilities makes it easy to keep them busy, and they’re built to operate in tight spaces. Operating costs are significantly lower than for larger excavators: Fuel costs are a third to half that of large machines, they can be towed behind a standard pickup and they require only basic operator training rather than a specialized certification.
Standard Excavators cost more to acquire and operate, and they don’t fit into tight spaces and smaller jobsites. But they are one of the most versatile pieces of construction equipment, and are generally in high demand. If your operation does most of its work on larger jobsites, a full-size excavator is a good bet to deliver healthy ROI. Otherwise, renting or subcontracting is a better bet.
Bulldozers and large loaders are necessities on big earthmoving projects, but they’re overkill on many jobs. A big price tag, high operating costs and specialized maintenance expertise make them specialty items – best for companies that do more earthmoving than anything else. A new mid-size bulldozer like Caterpillar’s D6 is priced around $500,000, and EquipmentWorld notes that operator skill is especially important – both in terms of how much the dozer gets done in a day and the amount of abuse its damage-prone undercarriage takes. Getting ROI out of such equipment is a discipline for large companies and earthmoving specialists.
Generators are a jobsite necessity. Utilization isn’t likely to be an issue – but unscheduled downtime can shut down an entire jobsite. Construction generators are readily available to rent in most metropolitan areas, with the rental company responsible for maintenance. As a result, the ROI on a rental can be as high as 80% with none of the risk of ownership, according to rental service JC Davis Power. Portable generators are important items for any construction firm, but supplying larger amounts of power is a job best left to specialists.
Cranes are specialized items in almost every sense and it takes a certain kind of business to get ROI out of them. Different jobs require different types of cranes, skilled operators are in short supply, transport is expensive and safety concerns necessitate lots of maintenance. All things considered, a crane is more likely than other types of equipment to spend most of its time sitting idle and is a poor ROI bet for most small and mid-sized contracting businesses.
Planning to Achieve ROI
When it comes to profitability, the best equipment is that which gets used every day. Machinery that sits idle not only fails to generate revenue, it also ties up cash through loan payments, depreciation, insurance and storage. In a cash-sensitive business like construction, that’s rarely a risk worth taking.
- Can do multiple jobs
- Transports easily
- Is affordable to maintain
- Requires only basic operator training
- Will get used nearly every day and fits in with most of your jobs
The assumptions used for estimating Revenue Generated in the ROI calculation should be built into a forward-looking plan. If you expect the equipment will help to bring in new work, make sure it’s specified in proposals and then keep track of the hours of use it gets. Also, build time for routine maintenance into work schedules to assure the upkeep is done between jobs rather than waiting for it to fail at the jobsite.
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