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Thread: What is a Reasonable Annual Percentage of Total Revenue to Spend on Improvements?

  1. #1

    Default What is a Reasonable Annual Percentage of Total Revenue to Spend on Improvements?

    Hi, thanks for this great forum.

    I own a small manufacturing business that is growing steadily. This is still a side business, but I plan to begin transitioning out of my day job over the next few years.

    We will finally turn a profit this year but actually have the past few years due to many write-offs we're allowed to take.

    I've built this all on sweat equity, all cash -- no credit cards or debt; no financiing or loans -- and we have a solid cash reserve.

    I've never run a business so I'm learning as I'm going, but I've disciplined myself to be conservative in our expenses. We need to buy some new equipment this year for our shop. Is there a well-known or general guideline ratio one should spend on such things? Right now it's looking like I'd want to spend about 25% of our gross revenues this year for our needed machinery. BTW, I'm very patient and aggressive on finding used machinery on the internet for a fraction of the cost of new, so we're getting much more for our buck than the average bear.

    Is 25% a reasonable number? In the ball park?

    I appreciate your feedback and suggestions,
    Homerun Hitter

  2. #2

    Default

    I think it's a little hard to come up with a "reasonable number" without a little more info.

    1. Will the new equipment increase your sales and/or decrease your expenses at all? This would help the equipment pay for itself to some degree.
    2. Did you want to pay cash for the equipment or would you be willing to finance it? Given the cost of the equipment compared to your sales, financing this purchase would make the most sense.

    Like you, I tried to avoid debt on my books if possible, but it can work to your advantage if you use it right. Interest rates are extremely low right now, so it is an easy choice if you can get the financing. For example, a 5 year loan would lower your equipment cost from 25% of a year's revenue to just 5% per year and the interest payments would be deductible on your taxes. I am sure that you wouldn't even think twice about buying something that costs 5% of your revenue per year.

    Hope this helps a bit!

  3. #3

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    Quote Originally Posted by RetiredMfr View Post
    I think it's a little hard to come up with a "reasonable number" without a little more info.

    1. Will the new equipment increase your sales and/or decrease your expenses at all? This would help the equipment pay for itself to some degree.
    2. Did you want to pay cash for the equipment or would you be willing to finance it? Given the cost of the equipment compared to your sales, financing this purchase would make the most sense.

    Like you, I tried to avoid debt on my books if possible, but it can work to your advantage if you use it right. Interest rates are extremely low right now, so it is an easy choice if you can get the financing. For example, a 5 year loan would lower your equipment cost from 25% of a year's revenue to just 5% per year and the interest payments would be deductible on your taxes. I am sure that you wouldn't even think twice about buying something that costs 5% of your revenue per year.

    Hope this helps a bit!
    Thanks for your post and response. These are all good questions.

    1) Yes, the machinery will immediately increase revenues and reduce outsourcing and machining costs. We make a small musical accessory. The materials we use are very expensive and/or hard to work on. For years we jobbed out everything, but two years ago I acquired a laser cutter (for cash) which brought almost all that work in-house. We now need to acquire a small benchtop CNC router, which will run no more than $2000. More on this below.

    2) I pay cash for everything. I have a revenue goal to hit before I purchase the thing. However, I'm a teacher and need to acquire it before the end of summer, to give me time to learn how to use it. I might be willing to put it on an interest-free credit card and pay it off in 12 monthly installments, but I prefer to just buy something outright and own it lock, stock and barrel.

    Our main issue is that our product involves too much hand-work, which drives up costs and slows our turns. Our lead times run three to four weeks on our most popular products, which people pay in full ahead of time (or business is more than 50% repeat clientele).

    Thanks for your analysis. You make a strong case. But I'm likely to pay cash and stay liquid. Also, we are at work on a product unique to our industry that could have patent possibilities and could be huge for us. I like having money in the bank.

    BTW, I did not receive notification of your post. Is there a trick to making notifications work on this site? I'm new here.

    Thanks Again,
    HH
    Last edited by Homerun Hitter; 04-18-2021 at 01:10 AM.

  4. #4

    Default

    I'm pretty new here too, so I don't know how to activate notifications either.

    As far as your equipment purchase, I guess I should have asked about the cost too. You would probably look at things much differently if your CNC router cost $20,000 or $200,000 rather than $2,000. Keep that in mind for when you get bigger!

    Good luck with your expansion!

  5. #5

    Default

    Quote Originally Posted by RetiredMfr View Post
    I'm pretty new here too, so I don't know how to activate notifications either.

    As far as your equipment purchase, I guess I should have asked about the cost too. You would probably look at things much differently if your CNC router cost $20,000 or $200,000 rather than $2,000. Keep that in mind for when you get bigger!

    Good luck with your expansion!
    Thanks, yes. One step at a time. Our product is less than 2" x 2", so a larger CNC machine would not need to be in our future any time soon. There are actually some excellent machines on the market now for around $1000 that will get us down the road quite a ways.

    Nice meeting you. Thanks again for the chat.

    HH

  6. #6
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    There really is no magic bullet for how much to spend on improvements. I like to do either one or two "large" purchases a year or, if there are no planned upgrades, pay off any accrued debts that are acting as a drag on cashflow.

    $2000 seems like a lot right now, but you need figure out how much time (and the dollar value associated to that time) costs. If the $2000 router cuts your manual labour time by 75% and you can run multiple pieces per setup, your costing yourself a lot of money (called tripping over dollars trying to save a dime) by not having the router - even if your paying 21% interest on a credit card. I know what I would do if I were in your position, but I'm not you and you're not me (this is a good thing BTW).

    One other thing, if you do take on debt, make sure that you have a plan to pay it off in the event things go south on you.
    Brad Miedema
    Fulcrum Saw & Tool

  7. #7
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    Hi, You need to spend at least 15% of your revenues on marketing and sales, and preferably over 20% of revenues to really grow. If you do not spend at least 15% of revenues on sales, and more on marketing, then your company will have a very difficult time not just growing, but even surviving.

  8. #8

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    Thanks for this information!

  9. #9

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    Commercial software: These products are designed to fill a specific market need. Examples of commercial software include video games, mobile apps, and SaaS products. These programs are resold and can serve a potentially infinite number of users. For example, a hotel booking system would be developed by a software development company. While a commercial product can provide a competitive advantage, it may also provide a competitive advantage. Similarly, a SaaS product would provide a service for a specific market.

  10. #10
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    I don't know that I ever thought about capital expenditures in terms of percent of revenue. I tended to look more at need and the payback time. Like you I avoid debt. If I don't have the cash I don't buy it. Like you I also look for bargains. We started our manufacturing business with an investment of under $ 1,000.00 in equipment. Later I bought a 6 foot sheer for $ 1,500.00 from someone going out of business. A few years later I painted it and sold it on eBay for $ 3500.00. We bought a bigger new one at that time for 50K.

    In your situation it sounds like the equipment you want to buy will have a short payback time so 25% of revenues should be worth the investment. You seem to have all the right ideas and will do well in your business. Having no debt is a good way to go. When the economy crashed in 2008 our sales dropped from 3 million to 1.2 million and we lost 180K. I am not sure I would have made it if I had a lot of debt. We did start a big program to cut costs and even though our sales stayed low for a couple of years we at least made some profit.
    Ray Badger, Turbo Technologies, Inc.
    www.TurboTurf.com www.IceControlSprayers.com

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