Buying yesterday's technology with tomorrow's credit

When a company chooses to buy IT equipment using an instalment sale, it is essentially trading away a portion of tomorrow's credit for equipment that loses value the moment it is turned on. By the time the loan is repaid, the business has spent years of limited and costly credit on an asset that will never recover its purchase price. This is a trade that is often not explicitly discussed when the sale is made.

The instalment sale appears to be a simple and sensible method for acquiring necessary equipment. However, upon closer inspection, the true cost becomes apparent: the organization's borrowing capacity has been spent on an asset that will be worth less each year it is held. Once the asset reaches the end of its life, there is no way to avoid owning it and the associated costs of disposal.

Many finance professionals are familiar with IFRS16, which requires certain leases to be recorded on the balance sheet. However, most are unaware that an instalment sale does not qualify for this treatment. The asset and the corresponding loan liability are recorded immediately and remain on the balance sheet throughout the term, regardless of changes in accounting standards.

There is a silver lining in IFRS16: a specific exemption for low-value assets, such as laptops, desktops, printers, and small to medium servers. These items, when purchased for under US$5,000, can be treated off-balance sheet without any additional effort. This exemption allows businesses to keep their borrowing capacity intact for revenue-generating assets, rather than spending it on depreciating technology.

The impact of these accounting decisions goes beyond mere reporting. Every dollar of debt-equivalent liability, whether from an instalment sale, loan, overdraft, or capitalised lease, consumes credit headroom and affects covenant compliance, gearing ratios, and return-on-capital calculations. Using years of borrowing capacity to finance equipment that loses value from day one is an inefficient use of resources.

With the understanding that most IT hardware procurement can be off-balance sheet through operating leases, why would a company continue to use instalment sales or other forms of debt to finance aging technology? It is worth considering whether this is the best use of scarce and expensive credit facilities before signing any new agreements. CFOs are increasingly questioning whether credit facilities should be reserved for revenue-generating assets rather than being consumed by IT hardware that quickly becomes obsolete.