Whether your business needs a computer, a truck, a trailer, a tractor, a storage building or an indoor arena, the question is always cash—where will you find the money?
When you just need a piece of equipment for a short period of time or occasional use, your business may be able to save a lot of cash by renting. It might not make sense, for example, to buy a brush mower or a backhoe or posthole digger if you have a nearby equipment rental outfit that can supply your needs, or if you can hire an owner/operator for the day. When you need that equipment for regular use over the longer term, however, you will probably find yourself weighing the decision of whether to buy it or lease it.
Leasing’s biggest appeal is that it offers small business owners with limited capital a financing alternative to traditional loans. Leasing allows business owners to procure equipment they need to operate and grow without paying for loan applications, making large down payments, or tying up existing credit lines needed for operating capital. Payments can often be tailored to the business’s unique monthly or year-to-year cash flow. The business can expense the entire amount of the monthly payments. And an option to buy the equipment anyway and acquire an asset at the end of the leasing term is often built into the deal.
“Leasing is an alternative financing program,” says Steve Savino, credit manager of FarmTek in Dyersville, Iowa, which offers a lease-to-buy option on ClearSpan storage and livestock buildings. Businesses can qualify for rates that are usually 5 percent lower than consumer rates. That makes leasing an attractive alternative to bank financing. For the hobby horseman, Savino says, bank loans typically offer lower rates than those for consumer leases.
What makes business leasing so attractive??Suppliers like FarmTek or large vehicle dealerships can use their volume purchasing power to secure financing deals that individuals might find hard to negotiate for themselves. They can move more equipment because their customers have access to this additional source of financing. And the third-party buyers of these business leases are able to fully utilize the tax advantages of the equipment’s depreciation. So they are eager to buy and administer these rent-to-buy agreements, freeing suppliers to concentrate on sales.
No wonder that leasing has become big business. According to the Equipment Leasing Association (ELA), businesses (including agribusiness) financed $204 billion of equipment in 2003. ELA statistics show that 73 percent of small businesses use lease arrangements to finance the equipment they use and, at the end of the lease, they purchase the equipment more than half the time.
THE DECISION PROCESS
Major business decisions are seldom uncomplicated, however, and the decision to lease rather than purchase new equipment is no exception. First, it is important to understand exactly what kind of lease you are comparing to your bank financing option. Monthly payments, tax implications, and ownership options are very different under various leasing options.
For example, operating leases offer low monthly payments that may be tax deductible. However, operating leases are like renting—at the end of the leasing period, the lessee doesn’t own anything. The lessee usually has the option to buy the equipment for a balloon payment, continue leasing it, or return it to the lessor. These leases are typically used for things like computers or trucks.
Financing or capital leases are more like loans than renting. They usually spread the full value of the equipment out over a much longer period of years in order to keep monthly payments low. They usually allow the lessee the opportunity to own the equipment at the end of the lease for a minimal payment, often just a dollar. Leasing companies offer many leasing arrangements to give businesses creative financing options.
Leasing experts advise small business owners to take a hard, objective look at the whole financial picture and ask themselves some basic questions when making a decision to lease or buy equipment. Such as:
Why are you leasing?
Some of the arguments in favor of operating leases do not apply to the typical horse business. For example, many small businesses cite ease of upgrading as their main reason for leasing computers. However, most horse businesses use a computer primarily for word processing and bookkeeping and do not need to upgrade to cutting edge computer technology every two to three years.
Another argument for operating leases is that it is easy to dispose of the equipment at the end of the lease term. However, leasing only frees the lessee of the need to find a buyer for used equipment. While it might be an easy option to drive a leased truck back to the dealer, if there is any cost to return other types of equipment, the lessee literally pays the freight.
Unlike loans, however, leases do not appear as debt on a business’s balance sheet or use up a business’s line of credit. Depending on the business’s future cash needs, those may be important considerations. Loans typically do not cover transportation, installation or maintenance costs. Sometimes leasing agreements can be written to cover some of these peripheral costs.
How long do you plan to keep the equipment?
Leasing trucks and office equipment like computers works to best advantage when they are only leased for a short time, usually less than three years. The longer the term of a lease, the closer the lease payments come to the payments you would have paid if you took out a bank loan to buy the equipment.
If your ego demands that you have the latest and best model of whatever equipment you use, a short-term operating lease can help you keep up appearances without eating up capital. If, on the other hand, you like to wring every dollar out of your current truck, trailer or other equipment and do not mind using it beyond its depreciation period, leasing makes little sense for you.
What do you want to do with the equipment at the end of the lease?
The business owner must decide before signing the lease whether he or she wants to continue leasing the same equipment under new terms, lease new equipment, or purchase the leased equipment under one of several options.
Purchase options are often based on a percentage of fair market value or a percent of the original cost. As mentioned earlier, some leases offer a $1 buyout at the end of their term. Each option adds different costs to the lease, and these costs should be calculated in advance in order to compare the total cost of leasing vs. buying.
How important are tax and balance sheet considerations in your decision?
Leasing can be advantageous for companies subject to the alternative minimum tax. However, thanks to recent tax laws, businesses planning to acquire less than $400,000 in new assets may be better off purchasing and depreciating equipment than leasing it.
In the simplest terms, leased equipment is considered a deductible business expense while purchased equipment is carried on the books as an asset and any purchase loans are carried as debts or liabilities. Some companies find it hard to break the leasing cycle should they decide they want to build the asset side of their balance sheet.
If you are thinking about using leasing as a financing tool, says equine tax expert Patrick J. Hurley of Yorba Linda, California, your accountant should be the first to know. Thanks to recent tax law changes, he says, equestrian business owners can expense up to $100,000 annually for the purchase of horses or business equipment, provided that total purchases of depreciable property do not exceed $400,000. These and other tax law changes may tip the scales in favor of buying versus leasing.
“Capital leases may make sense for someone with poor credit who can’t qualify for a regular loan or who has particular cash flow concerns,” says Hurley. “Otherwise, they don’t make sense during periods of low interest.” Hurley also points out that many people do not understand that if they default on an operating lease, not only will they find their truck repossessed but they will probably still find themselves in court for failing to fulfill their leasing contract.
Business owners should keep in mind that leases are a marketing tool to help increase sales, says Hurley. The person paying cash or walking in with a bank loan may be able to negotiate a discount. The person who chooses to lease may have lower monthly payments but pay full retail price.
Anyone thinking of leasing has to do their homework and run a comparison of all the costs involved under all of their options in order to see which one makes the most sense for them. Business owners should go over lease terms carefully with an accountant or other financial expert to be sure they understand all of the implications before they sign on the dotted line.