Buying vs. leasing

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

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
[email protected].