RSM Resources

During the past decade, leasing has become the method of choice for financing business equipment. According to the Equipment Leasing Association (ELA), eight in 10 U.S. companies lease rather than buy their equipment. That’s because leasing can enhance a company’s financial performance and capital productivity. But before leaping on the leasing bandwagon, midsized businesses should study the fine print to ensure their decision supports their financial and strategic goals.

Advantages of leasing
Knowing the pros and cons of buying versus leasing capital equipment will help you decide which option works best for your company. Experts say leasing generally affords the following advantages compared with buying:

Improved cash flow. With leasing, you pay only for the time you use the equipment, rather than the value of the equipment. Lease pricing reflects residual value (equipment value at the end of the lease term), so monthly lease payments are usually lower than monthly loan payments, freeing up cash flow to meet other needs. Plus, lease payments typically cover not only the cost of equipment, but installation, maintenance and insurance.

Easier funding. Qualifications to secure a lease typically are more flexible than for loans. Lenders usually require a business plan and two or three years of business records before granting a loan, but lessors may require only six months of credit history.

Greater flexibility. As your business changes and grows, and technology becomes outdated, leasing enables you to add or upgrade equipment at any time during the lease term through add-on or master leases. You also may be able to dispose of leased equipment you don’t need during slow times without significant penalty.

Advantages of ownership
While equipment leasing has many advantages, ownership may sometimes be more beneficial to your business. Buying equipment offers:

Lower total cost. While leasing sometimes carries lower monthly payments,experts say it almost always costs less to buy when considering total costs. However, any comparison between purchase and lease options requires detailed analysis of many variables. For each transaction, consider the price, interest rate, down payment and fees. For purchases, factor in the rate of depreciation,sales tax and loan amount. For leases, consider the residual rate and security deposit. Other factors also may apply.

Greater control. When you own equipment, it counts as an asset and carries equity value. You also can do with it what you please. In an operating lease, the lessor transfers to the lessee only the right to temporarily use the equipment. At the end of the lease period, the lessee returns the equipment to the lessor. Since the lessee does not assume the risk of ownership, the lease expense is treated as an operating expense on the income statement and does not affect the balance sheet.

However, through a capital lease, a lessee can assume some of the risks and benefits of ownership. Such a lease counts as both an asset and a liability on the balance sheet. While the lessee can claim depreciation on the asset and deduct the interest expense of the lease payment each year, the lessee also is responsible for maintenance, taxes and insurance.

Buying vs. leasing: Tax considerations
When analyzing whether to buy or lease,tax advantages may cut both ways.

For example, Section 179 of the U.S. Internal Revenue Code allows you to fully deduct the cost of some newly purchased assets in the first year. Although not all equipment purchases are eligible for Section179 treatment, you still can receive tax savings for almost any business equipment through depreciation deductions.

On the other hand, a loan qualifies as debt, a lease as overhead expense. Accordingly, you can fully deduct lease payments —but only the interest portion of any loan payments — from your corporate taxes.In addition, because some leases are not reported as long-term debt or liabilities, they do not appear on your company’s financial statement. This helps you maintain favorable debt-to-equity ratios required by traditional lenders should you need to obtain credit for other purposes. It’s important to understand the difference between capabilities that are treated as a purchase and true, or operating, leases, which are not.

Tailor financing to your business
While buying and leasing each carry some obvious advantages, be sure you analyze how each alternative would apply to your business’s unique needs.

First, determine how and for how long you plan to use the equipment. Buying generally is the best option when you expect long-term use, usually seven years or more. Leasing is the likely way to go when you expect short-term use, usually three years or less. For example, if you need equipment that has the potential to depreciate rapidly, or equipment for a special project, a lease enables you to add or upgrade equipment more easily.

Second, determine what level of investment your company can afford. Prepare a cost-benefit analysis comparing your lease or loan payments with the revenue you expect to generate from the equipment. Be able to demonstrate how you plan to make payments under either scenario.

Third, make sure your lender or lessor understands your industry and can provide you with customized options that accommodate your business needs and requirements. Check with financial companies of all kinds, including banks, brokers and leasing specialists. Equipment vendors also may offer financing programs. Negotiate with several and make them compete for your business.

Terms to look for in a lease
Once you’ve selected a financing vendor, consider the following issues when negotiating or reviewing your lease agreement. Your lessor may not include many of the following provisions in a proposed contract. If you want to include them, be sure you stipulate them before signing. Have an accountant and attorney review the contract on your behalf.

Lease term. Lease terms usually run between 12 and 36 months. The shorter your lease term, the higher your payments. The cost of a 12-month lease is usually prohibitively high, and many experts recommend you look at this option only if you have a compelling need.

Total cost.Analyze all the charges for which you will be accountable during your lease term. These include your initial down payment (if any), delivery charges,installation costs, monthly payments, security deposit, insurance charges,service or repair costs, and so on.

Cancellation clause. This allows you to break your lease, although you may be liable for large termination fees (often, the termination price is the total of all payments remaining). This way, if you close your business, shift strategies or no longer need the equipment, you won’t be liable for the entire lease term.

Assignment. Find out if you can assign the lease to another party, and if so, at what cost.

Modern equipment substitution. For technology that changes rapidly, you might want to consider this option. This allows you to update or exchange your equipment so you don’t get stuck with anything that becomes obsolete.

Service plans. Find out if your lease comes with an on-site service plan,and if so, determine its length. If you have only one year of on-site service,you may need to extend it through the lease term; otherwise, you will be responsible for all repairs after the first year.

End-of-lease options. At the end of a lease, you can return the equipment, buy the equipment at fair market value or a nominal fixed price, or renew the lease. Once you’ve decided which option you want, be sure to specify it in the lease documentation. Be careful, as the classification of the contract as a true lease or a purchase can change with changes in this feature.

In today’s rapidly changing business environment, savvy midsized businesses consider all options before financing business equipment. Carefully analyze the advantages of buying versus leasing as they relate to your company’s unique equipment needs, and choose the strategy that most helps meet your business goals.

Questions to ask prospective lender or lessor

• How well do you understand my business? Are you familiar with the different types of equipment we use?
• Does your company provide a variety of tailored products to meet my company’s needs?
• Do the loan or lease terms realistically address my budget needs?
• Does the financing structure improve cash flow?
• Will the end-of-lease or end-of-loan options meet my future needs?