Equipment Lease Financing
It has become increasingly more common in recent years for companies to lease equipment. Cash-starved businesses may want to consider leasing, rather than buying, equipment. Leasing gives you access to many types of equipment: computers, copy machines, fax machines, trucks and more. And while leasing doesn't bring cash in the door, it does reduce the amount of cash you will need to raise for your business.
When you lease equipment, a manufacturer, dealer or lender either buys or already owns the equipment you want. In exchange, you make monthly payments to the owner (lessor). The monthly payment structure typically allows you to treat the payments as tax-deductible business expenses.
Each leasing agreement needs to be read through carefully to understand the terms and conditions within. When leasing, be sure to consider the following points:
Lease term. What is the lease term The length of the lease will affect the amount of your monthly payment, with a longer lease term usually meaning a lower monthly rent.
Upfront payment. What is the size of any upfront payment Can you reduce the upfront payment and amortize it over the life of the lease
Monthly payments. Are the monthly payments reasonable You can analyze the amount of the payment by determining the interest factor associated with the lease.
Return rights. For vendor-leased equipment, under what circumstances can you return the equipment if there are problems
Early termination. Do you have the right to terminate the lease early Most lessors will be reluctant to do this, but you may be able to negotiate an early termination right in exchange for payment of a fee.
Option to purchase. Try to negotiate a right to buy the equipment. Equipment lessors will often give you this right at the end of the lease term, usually for a fixed price (e.g., 10 percent of the purchase price of the equipment) or at fair market value.
Typically a lease can run anywhere from one to five years. Most equipment necessary in commercial businesses today, including technical equipment, can be leased. Some leases provide an option to then purchase the equipment at substantially less money when at the end of the term of the lease.
By leasing equipment, the following are the advantages and disadvantages :
Advantages of lease financing:
It offers fixed rate financing. You pay at the same rate monthly.
Leasing is inflation friendly. As the costs go up over five years, you still pay the same rate as when you began the lease, therefore making your dollar stretch farther. (In addition, the lease is not connected to the success of the business.
Therefore, no matter how well the business does, the lease rate does not change.)
There is less upfront cash outlay. You do not need to make large cash payments for the purchase of needed equipment.
Leasing better utilizes equipment. You lease and pay for equipment only for the time you need it.
You typically have an option to buy equipment at end of lease term.
You can keep upgrading. As new equipment becomes available you can upgrade to the latest models each time your lease ends.
Typically, it is easier to obtain lease financing than loans from commercial lenders.
It offers potential tax benefits depending on how the lease is structured.
One of the reasons for the popularity of leasing is the steady stream of new and improved technology. The cost of continually buying new equipment to meet changing and growing business needs can be difficult for most small businesses. For this reason leasing is very advantageous.
Leasing can also help you enhance your status to the lending community by improving your debt-to-equity and earnings-to-fixed assets ratios.
There are a variety of ways in which a lease can be structured. This provides greater flexibility so that the lease is structured to best accommodate the individual cash flow requirements of a specific business. For example, you may have balloon payments, step up or step down payments, deferred payments or even seasonal payments.
Disadvantages of lease financing:
Leasing is a preferred means of financing for certain businesses. However it is not for everyone. The type of industry and type of equipment required also need to be considered. Tax implications also need to be compared between leasing and purchasing equipment.
You have an obligation to continue making payments. Typically, leases may not be terminated before the original term is completed. Therefore, the lessee is responsible for paying off the lease. This can pose a major financial problem for the owners of a business experiences a downturn.
You have no equity, until you decide to purchase the equipment at the end of the lease term at which point the equipment has depreciated significantly.
Although you are not the owner, you are still responsible for maintaining the equipment as specified by the terms of the lease. Failure to do so can prove costly debt does not have to be considered a direct liability on your financial statements.
To evaluate lease versus borrow (buy) decisions following points need to be considered:
After-tax cash flows associated with alternative borrowing arrangements,
The period of time in which these cash flows occur, and
The opportunity cost of capital.
There is no doubt leasing is very important and decision for it can be evaluated according to the situation.
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