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Business Observer Tuesday, Sep. 24, 2013 8 years ago

Equipment: To buy, or lease?

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Commercial equipment leasing is becoming the best financial option for businesses of all sizes.
by: Cheryl O’Neill Staff Writer

According to the Equipment Leasing and Finance Association (ELFA), approximately 80% of U.S. companies lease some or all of their equipment, and there are thousands of equipment-leasing firms nationwide catering to that demand.
So why lease instead of buy your equipment? With a lease, you pay a certain monthly fee for the rights to use the equipment. At the end of the lease, you can return the equipment or choose to buy it outright for a pre-determined amount. Leasing is a great way for businesses to start, grow or expand to get the equipment they need for their businesses, whether it is a dishwasher for a restaurant, dump truck for a construction firm, machine tool or a point-of-sale system for a new retail outlet. We'll get more into why leasing is so popular below, but first you should know about your options when your lease ends.

There are three standard end-of-term options:

  • Fair Market Value (FMV): This type of lease may also be referred to as a true or operating lease. It provides several flexible options at the end of the lease such as to return the equipment to the lessor, renew the terms or the option to purchase the equipment at the fair market value. Many customers who purchase equipment that tends to rapidly decrease in value select this equipment lease structure.

  • 10% Purchase: This type of lease combines the capital lease and operating lease and it allows you to purchase your equipment for 10% of the purchase price at the end of the lease. This is a common lease option because by leaving a residual at the end of the lease, the lease payments will be lower than if the lease reflected the total equipment cost.

  • $1 Buyout: This type of lease may also be referred to as a capital lease. This type of lease guarantees the option to purchase the equipment for the amount of $1 at the end of the lease agreement. Customers that plan to keep the equipment at the end of the lease term typically select the dollar buyout option. With a dollar buyout, the equipment must be shown as an asset and depreciated.

    If you have recently paid cash for some new equipment or own equipment free and clear, there are some equipment leasing companies that can offer you cash for the equipment and convert your purchase into a lease. This is called a sales lease back. Certain credit guidelines must be met and certain documentation such as invoices and proof of payment must be provided.

    OK, so what are the advantages of leasing?

  • Conservation of Credit - A lease is not a loan. Borrowing reduces lines of credit. Leasing is thus a NEW credit source, which allows the customer increased borrowing capacity.

  • Off Balance Sheet Financing - An operating lease keeps the debt, and the corresponding asset, off the company's balance sheet. Therefore, borrowing debt covenants are circumvented, financial ratios are enhanced, borrowing capacity is increased and the company appears healthier.

  • Eliminates Obsolescence - The latest technology is available which maintains a competitive edge. Structured leases can allow upgrade and trade-up options to all customers.

  • Tax Benefits - True leases generally allow 100% of the monthly payment to be expensed whereas bank financing would only allow expensing the interest costs (accelerated depreciation).

  • Flexible Financing - Leasing provides fixed-rate financing with specially structured terms to accommodate the specific need of each and every company.

    So why do people lease?
    Companies lease equipment because leasing represents the best use of their financial resources. When capital is conserved by leasing equipment, it can be used for other company uses (increasing inventories, expanding sales, etc.). The average return on capital in business is 18% AFTER taxes. Businesses that do not lease operate at a competitive disadvantage. They deny themselves the productivity-enhancing effect of better equipment that they could otherwise obtain. They operate with older equipment than they could otherwise afford. Ultimately, they may lose the ability to compete, having higher costs and lower payments than better-run operations.

    Leasing also has its disadvantages. For example, the lifetime cost of the asset is generally going to be higher than if you purchased it. You are also giving up ownership interest, which can be especially costly if you rely on the equipment and find at the end of the lease that the equipment is too expensive to purchase outright, you might also find that you lose the tax benefits of depreciation deductions.

    Equipment Leasing Average Costs and Terms:

    Equipment leasing rates are determined based upon the size of the lease, your personal and business credit score, payment history and time in business.

    Equipment priced less than $100,000 usually comes with a higher finance rate - anywhere from 6% to 20% and larger, more expensive equipment can generally be leased with a financing rate of 6% to 8%. A+ credit with more than 2 years in business can be as low as 4.5% with full financials.

    Terms are usually 12 months to 60 months but can sometimes be longer depending on the type of equipment and the amount.

    Ask the following questions about each leasing source you investigate:

    1. Who are you dealing with? Is there a separate company financing the lease?
    2. How long has the company been in business?
    3. Do you understand the terms and conditions during and at the end of the lease?
    4. Is casualty insurance (required to cover damage to the equipment) included?
    5. Who pays the personal property tax?
    6. What are the options regarding upgrading and trading in equipment before the lease period expires?
    7. Who is responsible for repairs?

    You might consider working with an equipment leasing broker. They facilitate leasing contracts between a lender and a person or company. They work with financing companies, banks, manufacturers and retailers to secure the best deal for his or her client based on need, credit, and ability to pay. In other words, the broker is an intermediary between the user and the lender.

    Every lease decision is unique, so it's important to study the lease agreement carefully. Consider asking a lawyer to look over it before signing.

    Cheryl O'Neill Gowen is president and CEO of Alternative Funding Options. She works with business owners seeking cash flow from non-traditional sources, drawing on more than 30 years' experience in banking, financing and staffing. Contact her at: [email protected].

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