Setting up or expanding a business can be an expensive exercise. To provide yourself with the tools and equipment you will have to either buy items or lease items. Almost anything can be leased from office equipment to machinery and tools. This guide will help you consider the choice between buying and leasing as well as providing further knowledge around the process of leasing.
Leasing of plant and equipment is obtaining the use of machinery, vehicles, or other equipment on a rental basis. This avoids the need to invest capital in equipment. Ownership rests in the hands of the financial institution or leasing company, while the business has the actual use of it.
If you do not have the available cash, further details on ways of acquiring finance can be found in our guide on Financing.
WHY should I lease versus buy?
To understand which is best in your situation it is best to understand the various advantages and disadvantages of each.
Leasing advantages include: making lower monthly payments rather than buying upfront, getting a fixed financing rate instead of a floating interest rate, benefiting from tax deductions on leasing costs, conserving working capital and avoiding cash-devouring down payments, and gaining immediate access to the most up-to-date business tools. The equipment also shows up on your income statement as a lease expense rather than a purchase. If you purchase it, your balance sheet becomes less liquid. The leasing company may also be responsible for repairs saving you maintenance costs.
Leasing disadvantages: You may pay a higher price over the long term versus buying. Leasing commits you to retain a piece of equipment for a certain period, which can be problematic if your business is unstable. Some brands or models may not be available to lease.
Buying advantages: Allows you complete control over your purchase including selection, modifying, and selling the asset for cost recovery. You can control repairs and service intervals. In certain cases, you can claim depreciation as a tax deduction. No agreements or contracts to agree to.
Buying disadvantages: Requires you to have cash flow and might force you into buying a cheaper model. If technology is outdated you have no easy upgrade path other than selling. Unless a warranty or insurance policy exists, repairs and maintenance will be an additional expense.
WHAT do I need to understand about leasing?
If you are just starting a business you may find it difficult to lease equipment. Lease companies will look at your lack of credit history but may consider your personal rather than business credit history during the approval process.
There are four types of equipment leases:
Finance Lease: Ownership of the equipment is with the business. It is on-balance sheet. Lease payments are tax-deductible. At the end of the lease, the equipment is returned to the Lessee or purchased by the business for an agreed price.
Operating Lease (Rental): Ownership of the equipment remains with the Lessor (it is off-balance sheet). Financing payments are tax-deductible. At the end of the lease, the lessee returns the equipment to the lessor or purchased by the business for an agreed price.
Commercial Hire Purchase: Equipment is owned by the business and it is treated as on-balance sheet finance. Only the interest portion of the payments is tax-deductible. The business can claim depreciation deductions on the equipment. At the end of the term, the equipment remains with the company. Sometimes there is a residual value payment required.
Chattel Mortgage: Equipment is owned by the business and the interest component of the payment is tax-deductible. The business can claim depreciation deductions on the equipment. This is a traditional secured loan where the equipment acts as security for the Lender. At the end of the finance term, the borrower remains as the owner of the equipment.
Watch for balloon payments, here you make small monthly payments with a large payment at the end. While this allows you to conserve your cash flow, the final balloon payment may be more than the equipment is worth.
If your lease requires you to return the equipment at the end of the lease and it’s worth less than the value established in the contract, you may be responsible for paying the difference. Also, watch for additional charges such as wear and tear.
HOW to buy or lease equipment?
Buying equipment is fairly straight forward however when selecting the right product you should consider:
- What you need both now and in the future?
- Would it be more cost-effective to have someone else’s plant or machinery do the task for you?
- Do you have the right environment or space to operate this product?
- Is the quality or reliability of product critical and does the extra cost make sense?
- Do you need to buy new or will 2nd hand work?
- How easily and/or quickly can the product be repaired or serviced?
If you decide to lease, the above list also applies. You can secure an equipment lease through:
- Banks and bank-affiliated firms. Banks may offer advantages, like lower costs and better customer service. Check whether the bank will keep and service the lease transaction after it’s set up.
- Equipment dealers and distributors can help you arrange to finance using owned leasing subsidiaries or an independent leasing company.
- Independent leasing companies.
- Commercial leasing broker. Much like mortgage brokers, these people charge a fee to act as an intermediary between lessors and lessees.
Every lease decision is unique, so it’s important to study the lease agreement carefully. Compare the costs of leasing to the current interest rate, examining the terms to see if they’re favourable. What is the lease costing you? What are your savings? Compare those numbers to the cost of purchasing the same piece of equipment, and you’ll quickly see which is the more profitable route.
SUMMARY – Leasing versus buying equipment
There are advantage and disadvantages of both buying and leasing. Make sure you:
- Understand the tax consequences.
- Make sure the product and the financing meets your needs.
- Understand what the implications are at the end of a product’s useful life or the end of lease terms.
Your accountant should be able to advise you in these matters if you require additional assistance.