Welcome back, business strategists! One of the crucial aspects of your startup’s Zero2One journey is setting up the right pricing and sales strategy for your product or service. To make your product a success in the long run, this check box needs to be ticked before you expand into the marketplace. You can check out the previous blogs on how to make the product successful in the marketplace using strategic pricing and providing different financing options to the customers for the purchase of the product. This can serve as the master key to open the locks of efficient customer acquisition and sustained growth. From upfront payment to flexible loans or convenient leases, different financing options can bridge the gap between the product and the different types of market consumers.
Startup Case Study!
If you are not able to get the importance of the aspects mentioned above, consider here a startup which manufactures Warehouse logistics automation machines, with integrated cutting edge solutions powered by AI. Our startup, as you may have got, is a capital intensive business, which manufactures heavy durable machines. These equipment will have a high sticker price for the customers.
Now, what are the options for the customer to finance the buy of the equipment. As a startup, we can provide the options of upfront purchase, or providing the equipment on loan to the customer, or asking the customer to take the equipment on rent. The different options mentioned above will suit a diverse range of customers with different financial capabilities and needs. These flexible strategies can be game-changers, expanding your customer base and boosting your revenue. You can check the blog which explains this aspect of the pricing strategy in detail.
The basic funding model!
Moving forward with our startup, the most standard payment option that a consumer can use is purchasing the equipment upfront. This option is the most straightforward and fundamental. It asks the consumer to pay the total price of the equipment all at once, during the purchase. You might have heard of flashy offers like “Take home a scooter for just Rs 500 down payment.” In the case of upfront payment, however, the down payment equals the total price of the equipment—no instalments, no financing, just one full payment.
Imagine the clarity and simplicity of this option. No monthly bills, no interest rates, just a single transaction that secures the equipment entirely. This can be especially appealing to businesses with healthy cash flows, looking to avoid the complexities of financing.
Numbers behind Upfront Purchase
Now, let us work out the numbers for the case of upfront purchase of the product by the customer. We will analyse the upfront price that we set up for the customer, and understand whether it is the actual cost that the customer may be bearing, or whether there is any benefit of making the huge outflow of cash at once that makes the apparent cost to the customer less.
Coming to our example for the automation machinery company. Imagine we need to recover Rs 1 Lakh for each piece of equipment which is our anchor number to be recovered to get back our initial costs as well as desired margins. Say each equipment has a usable life of 10 years. The invoice value, including GST (18%), for buying the equipment outright would amount to Rs 1.18 Lakh. We will assume a corporate tax rate of 25% here. Don’t worry if you are worried about why the corporate tax is mentioned above, it will be used in the coming sections.
Need for other Financing Alternatives
Now, here’s where things get interesting. That initial Rs 1.18 Lakh outflow might seem daunting. Especially for small businesses with minimal inventory and even for larger ones with lower profitability. For instance, for a company making Rs 10 Lakh in annual revenue, that upfront payment expenditure could be a significant burden. Conversely, a business with Rs 50 Crore in yearly revenue and Rs 2.5 Crore in annual profit might hardly notice the expense.
So, purchasing the equipment outright might make sense for larger, profitable businesses. But it might not be the best move for startups or smaller enterprises. For these companies, options like leasing the equipment or buying it through a loan (EMI) could offer more financial flexibility. We’ll explore these financing alternatives in our upcoming blogs.
Depreciation
Here’s a critical aspect of the upfront payment mode! As we discussed previously, the actual cost of purchasing the equipment is lower than the apparent Rs 1.18 Lakh initial outlay. This is because the equipment depreciates over time, and depreciation is tax-deductible. We factor the present value of these tax benefits each year, assuming straight-line depreciation. Eventually, the effective cost of purchasing the equipment today comes down to approximately Rs 96,287.
The Straight line depreciation we discussed above is a form of depreciation in which the equipment depreciates equally over its useful life. This means we assume that the value of the equipment is equal across its lifetime.
Discounting future cash flows to Present
Also, it is important to note that we have subtracted the present value (PV) of tax benefits each year to calculate the effective cost of equipment. This is because money today is more valuable than money in the future. By accounting for the present value of these tax deductions, we can accurately assess the true cost of purchasing equipment upfront.
So remember, the apparent cost is the actual cost minus the present value of tax exemptions on depreciation every year for the usable life of the equipment that is 10 years.
Apparent Cost = 1,00,000*(1+18%)= 1,18,000
Actual Cost = Apparent Cost – Σ (PV of Tax Exemptions on depreciation of equipment)
Actual Cost = 1,18,000 – 21,712 = 96,288
Have a look at the excel where the numbers and formulas have been worked out.
While the initial cash outflow might be Rs 1.18 Lakh, the effective cost considering tax benefits is close to Rs 96,288. It’s all about understanding these nuances to make the best financial decisions for customers while deciding to purchase equipment. Also, it is important for companies selling these equipment to create awareness among the customers regarding these tax exemptions as it makes it more lucrative for them to purchase the equipment keeping in mind these exemptions which’ll also help these companies get more customers.
Signing Off
In conclusion, opting to purchase equipment upfront offers a clear and immediate financial commitment. But its lasting advantages often outweigh the initial investment. For companies with strong cash flow and a focus on long-term financial efficiency. This choice grants full ownership and significant cost savings over time. However, it’s crucial to align your decision with your business’s financial health and strategic goals.
Understanding the finer details of upfront payment purchase—like tax benefits and depreciation—will empower you to make smart financial decisions that pave the way for future growth.
Stay tuned as we dive into leasing and loan options in our next blogs. Then we can delve deeper into the comparison of the various strategic pricing blogs that we would have developed. It will be really insightful for you guys to tailor your financial strategy, both as a consumer and as a business owner.