Companies regularly find themselves in the position of having to invest in equipment that will allow them to continue growing their businesses. If those businesses are startups, the need is sometimes more urgent, as they require capital-intensive equipment to get their operations up and running. (For instance, a high-quality copier would be a more pertinent piece of equipment for a new print shop than it would be for an Italian restaurant.) At these business crossroads, managers begin questioning whether they should lease or buy their equipment and look to their external business partners for advice.
At its core, leasing should be looked at for what it is: an alternative means of financing capital equipment that may result in benefits to the business, depending on the situation and available resources. With a wide variety of business equipment available for lease – everything from printers and copiers to product scanners, telephone systems, video surveillance systems, forklifts, mail room equipment, material or product handling equipment, industrial or commercial lighting and more – it’s worth taking the time to consider the benefits of leasing.
Understanding the Potential Benefits of Leasing
Minimize your initial investment. Leasing spreads the cost of equipment over a set period of time. Rather than having one large outlay of cash, companies can secure the assets they need without significant upfront cash, manage cash flow with predictable monthly payments – and free up scarce cash for other needs. Having a fixed lease payment amount also protects against interest rate increases that could be part of a long-term capital equipment loan.
Reduce the negative impacts of outdated equipment. Many types of equipment become obsolete in a relatively short period of time, like multi-function printers, security systems, software, computer hardware and others. When you own your equipment, you must pay to replace it or upgrade it to maintain optimum performance. When you lease; however, the lease agreement can be structured to include appropriate upgrades or replacement of outdated or obsolete models with newer versions, sometimes through a lease extension.
Minimize maintenance costs. Often regular maintenance and repairs are included in leasing agreements, eliminating the (often unexpected) out-of-pocket expenses associated with keeping equipment running as intended.
Provide flexibility. Equipment lenders can typically structure leases in a way that best meets the needs of a business. You may need flexibility related to the monthly payment amounts, terms of the lease, frequency of payments and end-of-term options.
Before deciding to lease, consider these questions:
- Would a lease expense be more beneficial than depreciation expense? Talk with a CPA to determine if the allowable depreciation expense (and the deductible interest if you borrowed to purchase) of a capital asset is more favorable than predictable payments and other benefits of leasing. Leasing is often 100% tax-deductible as an operational expense under the 179 IRS Tax Code. Keep in mind; you’ll want to understand the differences between an operating lease and a capital lease as the tax treatments are different.
- Do we want to own the equipment at the end of the lease? There are different types of leases, including “$1 out” leases and fair market value leases. With a $1 out lease, you own the equipment at the end of the lease term. In comparison, at the end of a fair market lease, you’ll have the option of returning the equipment, purchasing it, or extending the lease. Be certain that you understand in specific terms what happens at the end of the lease, since returning some types of equipment can be both expensive and disruptive!
- What lease term is best for the business? The length of the lease is one variable used to determine monthly payment, but also consider the useful life of the equipment. It’s not practical to extend the lease terms beyond that useful life, as you’re then paying for the equipment longer than its providing top value to your company.
There are, of course, downsides to leasing. First, you don’t own the equipment so you won’t gain any equity and you can’t sell. Secondly, you’ll typically pay more over the course of a lease for the equipment than you would be paying for it outright. Finally, even if you determine after a period of time that you don’t need the equipment, you’re nevertheless obligated to pay the remaining lease term. Even considering all of these downsides, though, leasing is often a practical way to acquire equipment in a way that doesn’t require a large outlay of cash and helps manage cash flow.
If you’re thinking about acquiring any type of capital equipment, talk with your CPA and banker for insights and guidance to gain a full understanding of leasing vs. buying. Recognizing the long-term implications on your productivity, profitability, cash flow and tax liability will help you determine the most appropriate approach for your business.