If you are a business owner, you will know that one of the biggest expenses in the company is your equipment. Whether you are a start-up company or a corporate giant, the fact is that equipment takes a large chunk out of your working cash flow each and every month. Together with rent and wages, equipment falls under the top three most crucial expenses in a business.
In saying that, equipment, like the labor and property, is one of the most crucial to keep the business running. If you are in hospitality, you will need vital kitchen equipment like fridges, grills, and ovens. Industrial plants and manufacturing businesses spend millions on equipment every year to produce their products. Even offices and technology hubs need vital equipment like laptops and printers to run.
Buying this equipment outright is usually unattainable for most companies. Even in cases where there is a large enough cash flow to make a large one-off purchase, it is usually in the company’s interest to rather make use of financing options like leasing. So, we took a look at leasing and how can benefit a business. Below are the top seven advantages that leasing will have on the financial stability of your business.
It Encourages Business Growth With Reduced Risk
As mentioned, your business needs critical equipment to function, but this equipment can come with a massive price tag. Leasing mitigates the risk of a large upfront payment that will put a lot of pressure on your business.
When you make a large purchase, you do so with your working cash flow. This is where your monthly expenses like wages, rent, and other monthly expenses come from. By taking a large chunk out of that, you might be putting the rest of your monthly expenses at risk.
Consider the impact that COVID-19 had on businesses, for example. Both small and large businesses alike were impacted by the pandemic that spread across the world. Cash flows received a direct hit and most companies were taken completely by surprise by the sudden drop in monthly income. This, together with new equipment purchases could cripple a business, so it is usually more advisable to reduce that risk and spread the cost of vital equipment over a period of time.
It Increases Your Purchasing Power
Apart from reducing the risk to your working cash flow, and monthly expenses, leasing is also incredibly attractive to other creditors and investors too. Leasing provides companies with a credit history, and the more regular and on-time monthly payments reflect on the books, the more stable the company looks to other creditors.
Leases are also recorded differently compared to bought equipment and make for attractive figures when the books are examined by third parties.
In essence, you can choose from a number of different leases, the two primary being operating and capital leases. Capital leases usually result in the lessee taking over ownership of the equipment, while operating leases allow the lessee to choose whether to return it or re-lease it after the period of time.
Both of these will be recorded differently on the balance sheet. Capital leases, because you will eventually own it, are recorded as a liability but the market value of the equipment will be recorded on the balance sheet as an asset.
An operating lease, on the other hand, is recorded as an expense on the balance sheet. It won’t need to be considered a debt and the depreciation of the equipment won’t need to be recorded at all. This will indicate to a third party that you have working capital available to make use of on a month-to-month basis. They will also see bought equipment as a depreciating asset, and when it comes to operating leases, you remove that risk entirely.
A Lease Is Entirely Financed
One of the biggest differences in signing a lease, especially an operating lease, compared to buying equipment is that the lease encompasses everything related to the equipment. When you purchase equipment straight up, your ownership of it means that you are fully responsible for everything about that piece of equipment.
In the case of a lease, the lessor, who is still the owner of the equipment, is responsible for the aspects such as maintenance and insurance of the equipment. This means less monthly and annual expenses that you need to worry about.
If you negotiate correctly with the financing company, you can also have various other equipment-related expenses factored into the lease. Installation costs, freight and transport costs, service contracts, training costs, and sales taxes can all be incorporated into the lease if you negotiate correctly.
Leasing Allows You To Stay Up To Date
Technology is constantly evolving. Every few months there seems to be an upgrade to some pricey equipment, making the former somewhat obsolete. Leasing reduces the risk of buying vital equipment, that in a few months, will be replaced with something more advanced and fresher.
If you look at laptops, or mobile phones in an office environment, for example. Making a mass purchase of this kind of equipment will seem futile for your company, as in two years, there will be new technology out which will make communication and operating so much easier.
Leasing, therefore, eliminates obsolescence. You have the flexibility of acquiring new equipment that is vital for your day-to-day operations, and after a few years, swapping it out for something more advanced without any risk to your business. You can choose to keep leasing or sign a new lease with the new equipment.
Upgrading, especially with an operating lease is simple to do. Once you have completed the term with the lessor, you are able to re-negotiate terms for new equipment or to have the current equipment upgraded according to your needs. Keep in mind too, if its equipment that requires regular upgrades during the course of the lease, you can negotiate this into the contract.
It Has Great Tax Benefits
Apart from the fact that you can spread out payments for critical equipment over a duration of months, one of the top advantages of leasing are the tax benefits. In order to get the most out of your lease, speak to a knowledgeable tax consultant who will be able to assist you with reporting it correctly, and ensure that you are positioned in such a way that you get as much back from the lease as possible.
Lease payments are, in most cases, considered tax-deductible as “ordinary and necessary” business expenses. If you sign an operating lease, from a financial reporting perspective, it will show up as a liability. But is also listed as an operating expense, as mentioned, and the payments themselves are considered necessary for business operations and can be written off.
In these cases, the short term of the lease means that it will not be considered a debt and you will not need to record the depreciation of the asset. These payments are usually 100% tax-deductible, which means that you end up paying even less at the end of the day on the equipment.
You will also be able to write off the interest of the lease as this is tax deductible. So, in the long run, you can actually make a lot back from leasing equipment by tax write-offs, and pay less for equipment that you really need.
Leasing Hedges Against Inflation
The option of leasing also allows for the lessee to be guaranteed equipment for a period of time at a set cost. You will not, unless you default on payments, lose the equipment, and you are not at risk of paying more for the equipment based on economic fluctuations.
This is a clear strong advantage as rising and falling interest rates can impact installments on certain financing options, but in the case of leasing, these are determined at the outset of the lease.
The other advantage lies in the fact that the lease amount is agreed at today’s cost of the equipment. Your monthly expense for the equipment, for the remainder of the term, comes out of tomorrow’s inflated dollar price, so you, in the long run, will be benefiting financially from signing a lease just the right time to get as much as you can out of the equipment. As they say, get more bang for your buck!
Leasing Is Convenient and Easy to Acquire
One of the aspects of leasing which is incredibly attractive to companies, especially start-ups, is that it is an incredibly simple, convenient process. Finance houses usually lease out their own equipment to companies and use that equipment as collateral. A lease can be canceled at any time, should the lessee no longer be able to afford the monthly installments, which means that the lessor can simply take back the equipment.
The process of signing for a lease is also much simpler than making an outright purchase or renting. In most cases, new start-ups do not have any credit history, and this may count against them when it comes to financing. In the case of leasing, finance companies will consider the company, and also take the owner’s personal credit history into consideration when agreeing to a lease.
The leasing process is also usually straightforward and swift. Many leases can be initiated online, should the finance company offer those facilities. They will also be somewhat quick to turn-over and you will usually not have to wait more than 72 hours to find out whether you have been approved or not.
It Allows For Great Flexibility For Both Lessor and Lessee
Leasing terms can also be incredibly flexible if you negotiate them correctly from the outset. You will be able to negotiate various clauses and terms on the lease like the duration of the lease, interest rates, and monthly payments.
It is important to consider your monthly repayments when signing a lease. In order to get the most out of the lease as possible, you will need to know the average cost of the equipment, and what kind of lease you are signing for. This will help you determine whether you are paying a fair installment on the equipment. The rule of thumb is as follows:
- For a capital lease; the lease term should cover the majority of the equipment’s remaining economic life. This is considered to be 75% or more of the remaining economic life. So, if you are going to be purchasing the equipment at the end of the term, the sum of all the installments should not be more than 75% of the value of the equipment. When you add the residual payment to the total of all the lease payments made, they should match, the fair value of the underlying asset.
- In the case of an operating lease, the sum of all lease payments should not exceed 90% of the equipment’s fair market value.
As mentioned previously, aspects such as maintenance and insurance responsibilities can also be determined prior to signing, and should you be signing a capital lease, this will be transferred to you once the lease has come to an end.
Once you have gone through the decision-making process of signing a lease, one of the vital things to consider is the company that will be financing your lease. You will need to ensure that you choose a company that is not only reputable but will take your needs into consideration.
By conducting research at the beginning of the process, you will be able to establish your risk appetite, as well as reduce the risk to your company by knowing the ins and outs of the agreement you are signing.
Make sure, at all times, that you have done enough research into the company too as this will reduce any risk to your company. Spend some time in getting to know the company and what they have to offer. Find out if they are open to negotiating terms, and what benefits they can offer when you lease with them.