vs. Buying Business Equipment
COMMERCIAL MORTGAGES CALIFORNIA
ORANGE COUNTY, SAN DIEGO, LOS ANGELES,
SAN FRANCISCO, SAN JOSE
Leasing vs. Buying Business Equipment
By Karl Walinskas • 457 Views
make more sense to lease business equipment or buy business
equipment? As we slowly and tentatively ease into what the talking
heads on TV are calling an economic recovery, you may be thinking
about upgrading that outdated processing equipment and getting
a new machine that's better and faster. Perhaps you even see
your backlog increasing again and you're realizing you have
ridden your existing capacity until the wheels are falling off,
and if you want to grow the business, you need some equipment.
It might be wet process equipment, machine shop stuff, forklifts
or new PCs for the office, and depending on what it is, your
situation and plans, there are a several options to consider
so that you can put the equipment in place and start using it,
equipment is generally a better option for manufacturers who
have limited out-of-pocket capital and where business needs
require upgrading equipment every few years. trans.gifOffice
computers and copiers, for instance, are often leased strictly
to avoid obsolescence every few years. Purchased equipment may
be a better choice when the useful life of the equipment lasts
more than five years. Interestingly enough, there are leasing
programs available that end in equipment purchase at term that
still minimize up front cash required. Each company situation
is unique and you should make decisions on a case by case basis.
The primary advantage of leasing is that it allows you to acquire
assets with minimal initial expenditures. Because leasing rarely
requires a downpayment, you can obtain and make use of the equipment
you need without significantly affecting your cash flow. This
frees up cash for operations or other investments. Another financial
benefit of leasing, if you have a straight operating lease (read
that equipment rental contract), is that your lease payments
are generally 100% deductible on your corporate tax return in
the year they are paid as an operational expense of the business.
This effectively reduces the net cost of the lease and should
be considered. Leases for manufacturing equipment are usually
easier to obtain and have more flexible terms for buying equipment
than do loans, and this can be a tremendous advantage if you
have poor credit or need to negotiate a longer payment schedule
to ease the burden on your monthly cash flow.
also addresses the problem of equipment obsolescence. If you
secure machines with your lease that become technologically
outdated within a few years, a lease passes that burden to the
lessor, and gives you the freedom to lease newer, higher end
equipment at the completion of the lease term. Similar to obsolescence,
many manufacturers are awarded multi-year contracts by industry
or government (DOD, etc.). A typical lease relieves the manufacturer
of the burden of owning equipment he will no longer use upon
completion of the contract. If the contract is renewed or extended,
so may be the lease, or alternate options become available.
In fact, a lease is a nice option for any situation where the
long term viability of a current business opportunity is uncertain,
such as trial entry into new markets, products, etc. Translation:
equipment operating lease means you don't own the equipment,
you are paying for its use over the course of the lease. You
can relate to automobile leasing, and at the completion of the
lease, just as with cars, you have an option to buy the equipment
at a fixed price, usually the fair market value.
As I hinted
at earlier, there are also less traditional leases with higher
payment terms that result in a buyout at 10% of purchase or
$1, and this is more akin to traditional financing, except that
there are still low down payments and flexible terms. For tax
purposes, these leases are treated as capital purchases and
enjoy the tax benefits of ownership (such as section 179 advanced
depreciation rules, see Buying).
Leasing equipment has two primary disadvantages: overall cost
and lack of ownership. Leasing a piece of equipment is almost
always more expensive over the long haul than purchasing it
outright. For instance, a 3-year lease on computer equipment
worth $4000, at a standard rate of $40/$1000 price, will cost
you a total of $5760, whereas purchasing it outright costs $4000.
In addition to the higher cost, you will have built no equity
in the computers on a FMV (Fair Market Value) lease. Unless
the equipment has become totally obsolete at the end of the
lease, this is a significant drawback. In this example, even
as fast as computers lose their value upon leaving the store,
they would still have some residual value at the term of the
downside to leasing that many people have a hard time getting
their head around when also considering loans. You are obligated
to make payments for the entire lease period even if you cease
using the equipment. Some leases provide the option for early
cancellation if the business shifts direction during the term,
but substantial cancellation fees almost always apply. There
is also not much advantage to pre-pay off the lease, as you
don't gain any interest advantage, you simply are paying the
same amounts early. The one exception to this is tax advantages.
See your tax accountant on options for accelerating lease payments
to obtain more expense deductions in high income years.
The clearest advantages of buying manufacturing equipment is
the ownership you enjoy after the purchase. This is especially
true when the property has a long useful life and is not at
risk of technological obsolescence in the near future, such
as heavy fabrication or machine shop equipment.
another advantage that applies to purchases, whether paid for
with cash, financed with a loan, or a $1 buyout lease. Section
179 of the tax code allows first year complete deduction of
equipment necessary to the business up to certain limits (IRS
changes these yearly) as opposed to multi-year depreciation
or deduction of lease payments. Even if you are paying a $1
buyout lease over 5 years for $100,000 worth of equipment (if
your total is under the set limits), you can fully deduct it
in the first year. For this example, if you are in a 25% tax
bracket, that equipment really only costs you $75,000, because
you write off $25,000 in the first year you put it into service.
This should be a significant motivator that, no matter how you
finance the equipment, if you need equipment for your business
growth or sustainability, by all means max out this deduction.
When you purchase a capital asset via conventional equipment
loan, it goes on the company balance sheet as a liability. The
only tax advantage you receive if you are beyond your section
179 limitations is annual depreciation. Depending on the equipment
and its depreciation schedule, this may not be nearly as much
financially as the payments on, say, a three year operating
lease. If you pay cash for the equipment, obviously you bear
the opportunity cost of the money you could have spent on operational
expenses or other opportunities.
highlighted earlier, there is the problem of outdated equipment.
You may find yourself at the end of an equipment loan owning
an asset that has very low market resale value because it is
technologically obsolete. Now you have to repeat the process
and reinvest in new equipment again. Recall the computers example
earlier for $4000. If not purchased with cash, you go through
the pains of paying interest and financing a larger amount,
only to be left with equipment in 3 years worth a thousand dollars
or so. This is why many companies lease rapidly depreciating
equipment that, as a general rule, is always being updated with
a purchase via an equipment loan, understand also that approval
time for loans is usually longer than for a lease, with more
in-depth financial disclosure. If your company has an opportunity
to capitalize on a quickly developing opportunity and you don't
want to part with cash (or don't have it), financing via a loan
may not be the best option.
Should You Do?
When making the decision to purchase outright, take out an equipment
loan, or lease a piece of manufacturing equipment, first determine
the approximate net cost of the asset. Factor in the tax breaks,
opportunity cost of cash, and resale value we have talked about
in this article in addition to total price paid. After determining
which option is most cost effective, roll in intangible factors
such as equipment obsolescence or whether the need for the equipment
will cease before the term of a lease or loan. No one likes
to pay for something they are no longer using.
table illustrates some quick reference pros and cons of various
ways to buy new equipment:
Buy Pros and Cons