Banking and Finance

Buying vs. leasing

Print This Page

Send this page to a friend

Lance Vincent
Executive sales officer
Capital One Equipment Leasing and Finance

---

For some businesses, equipment is a vital part of their success. But so is profitability, and oftentimes making the decision to buy or lease new equipment can affect the bottom line.

There are many things to consider when deciding whether to buy or lease, says Lance Vincent, executive sales officer for Capital One Equipment Leasing and Finance in Dallas. Tax implications, financial ratios, budget restrictions, cash flow and value at maturity are the primary ones.

Smart Business asked Vincent to flesh out some of these considerations and also explain the myriad financing options available to businesses when it comes to buying or leasing equipment.

What kinds of things should a company consider when debating whether to buy or lease equipment?

First, consider the value at maturity. What is the value of the equipment to the business at the end of the lease? Will the business still want it? Will the equipment have been rendered obsolete? Does the business want to have the responsibility of selling it? This is a great place to start in analyzing whether a business should buy or lease.

The second thing a business should consider is the tax implications of buying versus leasing. Can it more efficiently (tax rate) use the tax benefits of expensing the interest and depreciation than a leasing company, and does the leasing company pass most of the benefits on to the business in the form of a lower rate? Things such as alternative minimum tax (AMT), loss carry-forwards, etc. affect how efficiently a business can utilize depreciation.

Third, consider cash flow. Buying or loans usually require large upfront outlays of cash. A lease is usually 100 percent financing. A business may feel it can invest this cash back into itself at a greater return than the cost of the lease. Also, many times a lease can be structured to better match the monthly cash expenses of acquiring new equipment against the income stream generated by that equipment.

The fourth thing to consider is financial ratios. Shareholders and banks value a customer on certain financial ratios (e.g. leverage), and leasing may improve these ratios at the expense of some absolute numbers.

Finally, consider the budget restrictions. Large companies and especially government entities may be limited on how much equipment they can acquire in any one year. Because leasing does not record the asset but only the expense, it may allow them to acquire needed equipment.

What percentage of total expenses does equipment typically comprise and why is the lease/buy decision so important?

About one-third of the $900 billion spent in 2007 on equipment purchases was done under leases. The decision is important because a business needs to make sure it has access to the most efficient equipment at the lowest net cost and the easiest degree of entry with the least negative impact on reporting.

Where does depreciation come into play in the buy/lease decision?

When it comes to depreciation, a business must ask itself if it can more efficiently use the depreciation against its tax obligation than a leasing company can. This depends on the business’s tax bracket, how profitable it is and how much equipment it has already purchased and is depreciating (alternative minimum tax considerations). It will also depend on current economic stimulus packages the governement is offering (e.g. accelerated depreciation and tax credits).

What financing options are available?

Businesses may consider the following financing options:

• Tax leases

• TRAC leases

• Operating leases

• Finance leases

• Skip payment leases

• High-low payments

• Low-high payments

• Lease lines of credit

Let me explain a couple. An operating lease is one that is structured to achieve off-balance sheet treatment. Some potential benefits are improved financial ratios, such as lower balance sheet leverage, improved cash flow coverage, improved ROA, etc. Additionally, some businesses choose an operating lease in order to help maintain the most current, state-of-the-art equipment by rolling off old, obsolete equipment and refreshing the lease with new equipment.

A TRAC (terminal rental adjustment clause) lease is the most common type of lease used for financing titled vehicles (e.g tractors, trailers, and other business use vehicles). The TRAC lease provides business owners with a tax advantaged lease, yet it also grants a fixed price purchase option for the vehicle at lease end, which is usually expressed as a percentage of the initial value. This lease typically results in a lower cost of capital while giving the business the option to either purchase the equipment (without a fair market value negotiation) or to refresh the fleet.

LANCE VINCENT is executive sales officer for Capital One Equipment Leasing and Finance in Dallas. Reach him at (972) 855-3927 or lance.vincent@capitalonebank.com.