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As the economy continues to improve, more manufacturers are making capital investments to fuel their growth. When business owners and managers consider acquiring equipment, they often think of their payment option as a lease vs. buy decision. In any economic environment, when preserving owner or shareholder capital is an important goal, financing equipment through a lease or loan will enable your business to preserve its cash.
Whether you finance equipment through a lease or loan, each has its advantages. In evaluating your options, it is important to look at each alternative to determine which will best balance usage, cash flow and your financial objectives. To help determine the most appropriate option, consider the following questions.
Generally speaking, if the length of time the equipment is expected to be used is short term (36 months or less), leasing is likely the preferable option. Equipment expected to be used for longer than three years could be a candidate for either a lease or loan.
As with any ongoing business expense, consider the monthly cost for a piece of equipment and how it fits into your budget. In general, leasing will provide lower monthly payments.
Protection against obsolescence is one of the many benefits of equipment leasing, since the risk of obsolescence is assumed by the lessor. Certain lease financing programs allow for technology upgrades and/or replacements within the term of the lease contract.
Often, the equipment's business objective is for it to be revenue-producing. If a piece of equipment has limited use within a specific contract and won't be used for other projects, it's not ideal for it to be idle while you continue to make payments on it. It makes sense to stop the equipment expense when the income from it ceases, which you can do with a lease.
Leasing can usually provide 100-percent financing of the equipment cost as well as the costs for transportation, delivery, installation setup, testing and training, and other deferred costs (e.g., sales tax). Loans usually require a down payment and don't include the other cost benefits. Ask how much of a down payment is needed and assess the availability and desirability of allocating company capital for the down payment.
The tax treatment of the financing arrangement is an important consideration in choosing between a lease and a loan. A loan provides you with the depreciation tax benefit. With a lease, the lessor owns the equipment and realizes the tax benefit, which is usually reflected in a lower monthly rent payment for the organization as well as the ability to expense the payment. In many instances, if your business cannot use the tax benefit, it makes more sense to lease than to purchase through a loan because you can trade the depreciation to the lessor in exchange for better cash flow.
Many businesses have an aggregate line of credit through a bank that they can use for inventory purchases, improvements and other capital expenditures. Depending on the lending covenants, it is often possible, as well as preferable, to preserve your bank working capital by leasing equipment through an equipment finance provider.
A lease can provide greater flexibility, since it can be structured for a variety of contingencies. With a loan, flexibility is subject to the lender's rules. If your business has continuing use for the equipment when the lease ends, extended rentals, purchase options, trade-ups and return options are available. The lease term allows your business to match all expenses to the term of the equipment's use, including income tax expense, book expense and cash expense. Most importantly, the expense stops when the equipment is no longer required.
If your business is planning for growth, you can enter into a master lease that will allow you to acquire multiple pieces of equipment under a number of schedules with the same basic terms and conditions. This provides greater convenience and flexibility than a conditional loan contract, which must be renegotiated for additional equipment acquisitions.
When making the decision between a lease and a loan, it is recommended that you consult with your accounting professional as well as draw on the resources of your equipment financing provider to enable you to secure the best possible terms for your lease and/or loan. For comparison and online tools, visit www.equipmentfinanceadvantage.org/ef101/llc.cfm.