Purchasing new manufacturing equipment can be a huge capital expense and a tough decision to make, but there are ways to plan and ensure it’s a good financial decision. If it is a worthwhile purchase it will have a high Return on Investment (ROI) rate. ROI is a useful performance metric for evaluating overall savings or revenue increases due to a specific piece of equipment after all other costs have been accounted for.
So how do you figure out the Return on Investment for an equipment purchase?
Before you can figure out the ROI of manufacturing equipment, you first need to calculate the Total Cost of Ownership (TCO). These are all the costs that come with operating and maintaining equipment, and should be done with both the old and potential new equipment. Factors to consider include maintenance and downtime, replacement parts, and how many employees are needed to operate the equipment.
Now that you have this number of the TCO and what you can potentially be saving, and what increased production will do to revenue, you can calculate the ROI of the manufacturing equipment.
The formula for ROI is Net Profit / Total Investment * 100 = ROI.
So if you make a new profit of $50,000 and spent $200,000 on new equipment, the ROI is 50,000 / 200,000 * 100 = 25% ROI.
Once you have this figured out, you can determine what the ideal payback period would be, which helps to determine what is affordable. This is just the cost of the purchased equipment divided by the amount of profit it is creating.
In the example above, this would be 200,000 / 50,000 = 4 years before the equipment has paid for itself and the company breaks even on the investment. All the years after that would be the company making pure profit off the equipment purchase.
Of course, there are factors other than just pure financial costs and calculations that go into a purchasing decision. Is the old equipment not safe anymore and needs to be replaced no matter what? Has your manufacturing process changed and the old equipment just doesn’t operate how you need anymore? Is it undersized for your increased production needs? Is the technology it uses so outdated that it’s causing issues?