business builder leasing
Should you lease or
buy capital assets?
How to decide
by Tom Klassen
ONE OF THE KEY decisions for any business is whether to lease vs. buy capital equipment.
Depending on the size of your business, and what services it offers, either option might be best. How do you know for sure? Read on to learn your options.
First, an explanation about leasing for businesses. An asset chosen by the lessee is acquired by a bank or finance company and then is leased to your business for a pre-determined period of time. The business does not have the title to the asset during the lease term, but has full use of the asset.
All types of capital equipment are leased, including construction equipment, forklifts, trucks, trailers, manufacturing machinery, machine tools, printing equipment, food processing equipment, medical equipment or office furniture and computers.
Leasing is a popular option, On average, 31 percent of all capital equipment acquired each year is financed through leasing.
Types of leases
Your choice of lease options depends upon your business’ specific situation.
In a finance lease, the asset generally appears on your balance sheet and is depreciated over the life of the lease, similar to a loan. This is a quick, easy and simple lease that requires little money up front and offers fixed rates over the life of the lease.
A tax lease helps expedite the write-off time on the leased equipment. Typically there is a five-to-seven-year depreciation schedule for equipment acquisitions.
A true tax structure allows the lessee to expense all lease payments on tax returns rather than depreciating over the term. Your business can expense the lease payments, which increases expenses and decreases the tax burden.
When structured as an operating lease, the lease payment is strictly an expense for both book and tax purposes and the bank or finance company takes the depreciation benefit.
An operating lease works well for companies that want the leased asset off of the balance sheet. The reasons for this vary, but usually help meet bank or bond covenants as well as improve certain operating ratios.
We recently worked with a business that had grown rapidly over the past few years and had become very profitable. They were looking to acquire a significant amount of equipment to help facilitate their increase in orders.
Traditionally, they had used the finance lease option for their equipment purchases with cash flow and minimal up front money as the primary motivation. Their circumstances had changed. Cash flow had become much stronger. Taxes owed had grown significantly as profits climbed.
We recommended they discuss a tax lease option with their certified public accountant to expedite the write-off of this new equipment. They eventually entered into three- and four-year tax leases allowing them to expense their equipment much more rapidly than the depreciation schedules allowed which ultimately saved significant tax dollars.
Benefits of leasing
One of the primary benefits attributed to all structures of leasing is 100 percent financing. Typically, one or two payments in advance are required to commence the lease. A reasonable amount of soft costs such as taxes, installation and training are often included in the lease as well.
Other benefits of leasing include fixed-rate financing, which is a good budgeting tool because the payment is always fixed during the term of the lease. Lease terms typically range from two to five years but may be extended even longer in some cases.
Leases generally are approved more quickly than loans, so you can get up and running sooner. Leases do not affect your bank line of credit. They can also be written with flexible terms to correspond with cash flow, which benefits seasonal companies.
This is important even to companies that normally would not be considered seasonal, but in which a few months of the year are more difficult than others on cash flow.
As an example, a trucking company may have significant expenses the first part of the year for insurance, licenses, etc. The ability to have flexible lease payments can be significant.
Read the fine print
There a few areas to focus on before entering into a lease. As with any type of agreement, you need to understand the structure and ramifications of the contract.
One of the most important pieces of the lease that is often misunderstood is the buyout option at lease-end. We often encourage lessees to fully understand their options as they compare various lessors.
A finance lease is usually fairly straightforward with a fixed purchase amount at the end of the lease. Tax and operating leases tend to be a little more complicated.
We have heard numerous stories of lessees getting to the end of lease term and being told by the lessor that the residual amount is significantly higher than the lessee expected.
Usually, the lease structure has a fair market value purchase option and the lessee had not realized the implications and what that may mean at lease-end. The key is to discuss the end of lease options before entering into the lease.
Understand the risks and make an educated decision based on the facts.
A few other things to consider include an early buyout option and how that will be calculated. Some leasing companies will be more favorable than others.
Lastly, when comparing quotes from various lessors, be sure that upfront payments, security deposits and fees are all disclosed. You don’t want unexpected fees to surface at the 11th hour before closing a lease.
Talking to your business banker and a leasing representative can help you make sense of the buying vs. leasing question. can help you make the decisions that will maximize your business potential and keep your costs in check.
[contact] Tom Klassen is vice president and leasing manager for Associated Bank in Red Wing: 651.385.1691; tom.klassen@associatedbank.com; www.associatedbank.com
