Manufacturing businesses have a lot of expenses. Many of those expenses are classified as overhead, which are the costs of production outside of the costs of labor and materials. Manufacturers especially need to be conscious of their overhead expenses, as manufacturing overhead tends to be more complex than that of other kinds of business. Overhead expenses can range in size from negligibly small to some of the biggest expenses you face.
Manufacturing business owners seeking financing for their operations will be interested to see that the target areas for the Small Business Administration (SBA) 504 loan overlap with the high manufacturing expenses—property and equipment, both for purchasing and renovation.
What Are Your Manufacturing Overhead Costs?
Manufacturing overhead comprises all the ongoing costs involved in manufacturing your product, except for direct labor and direct material, and is categorized into “fixed” and “variable” overhead. Rent is an example of fixed overhead, since it is the same regardless of the volume of output, while the electricity bill is likely to be variable overhead—the more electricity you consume, the higher the bill.
There are a large number of expenses that are classified as overhead. A nonexhaustive list includes:
- Rent for the building or property, or interest on mortgage payments
- Equipment and machinery
- Electricity, natural gas, water and sewer
- Computers and communication systems for the manufacturing process
- Repair parts for equipment
- Supplies for maintaining the manufacturing process
- Depreciation of the equipment and facilities
- Insurance and property taxes on the equipment and facilities
- Safety and environmental costs
Business owners can and should seek financing for the more expensive items on this list, such as property or machinery. By replacing rent payments with mortgage payments, the owner is investing in their future and creating equity that can be a great nest egg for retirement when that time comes. Financing equipment upgrades frees cash for other uses.
Why Knowing Your Overhead Matters
Overhead, labor, and materials are all the elements that make up the direct cost of production. These are not all of your expenses—sales, administration and logistics, for instance, have to be taken into consideration too. But overhead and production costs are important elements in your budget, and calculating them correctly is essential to guaranteeing profitability.
Overhead is a broad category of highly varied expenses. Often the largest expenses are rent and equipment upgrades and replacement. Thankfully, the SBA has crafted the 504 loan to help manufacturers and other small business owners buy a building and equipment for their business.
How Can A 504 Loan Help?
The SBA 504 loan is specifically targeted to financing land, building and equipment purchases. A 504 loan can be used for:
- The purchase of existing buildings
- The purchase of land and land improvements
- The construction of new facilities or modernizing, renovating or converting existing facilities
- The purchase of long-term machinery or equipment, with a life of at least 10 years
A 504 loan is a partnership between a conventional lender and a Certified Development Company (CDC), which is a nonprofit organization that administers the program on behalf of the SBA. 504 loans are available with 10- or 20-year terms. The loan has three parts:
- The first is a loan from a conventional lender for 50% of the total amount. You and that lender determine the amount and conditions of that loan, which becomes your first mortgage.
- Your CDC facilitates a separate SBA loan of 40% of the total, up to $5.5 million, at a fixed, below-market rate. This will be your second mortgage.
- Then you, the borrower, will contribute 10% to the loan.
- 50% Conventional Lender
- 40% CDC
- 10% Borrower
This low down payment opportunity is very valuable to manufacturers. Conventional loans can have down payments of up to 40%, which would take cash otherwise allotted for things like overhead costs, out of your pocket. The 504 loan, however, enables you to save as much working capital as possible. A lower down payment means more capital for other expenses, such as variable overhead. Also, the low interest rate means low monthly payments, contributing to lower fixed overhead as well.
For an example on how purchasing your building can have lasting and long term positive effects on your overhead, let’s look at TMC Financing client Gary Moore, owner and CEO of Diablo Cable. Moore observed that “When you’re leasing, you go to Costco and buy shelving units to store inventory. When you own, you can invest in custom industrial shelves that better meet your needs and have them professionally installed. It’s not inexpensive, but when you own you can think long-term and install space-saving racking that’s bolted to the floor and seismically secure. You just can’t do that when you’re leasing, and it makes all the difference in efficiency.”
Business owners thinking about establishing their manufacturing company and buying a facility can find themselves with more money at hand and more opportunities to create the operation they envision when using a 504 loan. The 504 loan saves money two ways. Its low down payment allows you to spend more on the things you need right away and its low interest saves you money for the whole life of the loan.
A 504 loan can make a vital difference to a business and the entire community it belongs to. “It’s hard be a manufacturer in the U.S. and be competitive,” Moor said. “In California, it’s even harder with the high wages and regulations: manufacturers in California are escaping to the hills. For us, owning the building was part of the solution. TMC is reviving a dying industry. ”
TMC Financing is one of the nation’s top-ranking CDCs and a Premier Certified Lender with the SBA. If your business is located in California or Nevada and are a manufacturer looking to expand, it might be time to talk to one of our local 504 loan experts.