Financial markets have grown and
become more sophisticated, and
that’s a good thing for companies looking to grow themselves. More options
exist than ever for companies to expand in
an increasingly competitive business
world.
“One of those options is equipment leasing, which is becoming an increasingly
popular way for businesses to achieve the
growth they’re eyeing in an affordable
way,” says Mark Heckler, group regional
president of commercial services for MB
Financial Bank.
Smart Business spoke with Heckler
about what kinds of equipment leases are
available to businesses and why they might
be a better bet than conventional financing.
Why should companies consider leasing
their equipment?
The growth and sophistication of financial markets has provided numerous capital sources to entrepreneurs to support the
expansion of their businesses, and equipment leasing is one of those ways. The
Equipment Leasing and Finance
Association’s Web site indicates that in
2005, 27 percent of fixed business investment [excluding software] was financed
via equipment leasing. This translates to
$234 billion in 2005 alone.
What kinds of leases are there?
Leases can be classified as either a capital or operating lease. A capital lease is a
type of lease classified and accounted for
by a lessee as a purchase and by the lessor
as a sale or financing, as long as it meets
any one of the following criteria: the lessor
transfers ownership to the lessee at the
end of the lease term; the lease contains an
option to purchase the equipment at a bargain price; the lease term is equal to 75 percent or more of the estimated economic
life of the equipment; or the present value
of minimum lease rental payments is equal
to 90 percent or more of the fair market
value of the leased equipment less related
investment tax credits retained by the lessor.
An operating lease is generally defined as any lease that’s not a capital lease. One of
the key characteristics of the capital lease
is that the lessee may be entitled to the
depreciation expense of the equipment
financed. The other consideration is that
under an operating lease, the lease payments are generally deductible for tax purposes whereas only a portion of the capital
lease payments may be. As always, it’s wise
to consult with outside professionals to
determine the tax effects of any lease
financing.
Another distinction is that a capital lease
is a form of financing whereby the lessee
will typically take ownership of the equipment at the end of the lease term. The lessee must determine at lease inception if the
particular equipment will be required for
the ongoing operation after the term. A
good rule of thumb is that if the equipment
will likely be replaced at the end of the
lease, an operating lease may be an attractive option. Reasons for replacement may
include changes in technology, changes in
business processes or a perceived need to
upgrade. Operating leases are generally
suitable for IT, material handling, telecom
and production equipment as these assets
are frequently upgraded or replaced after
several years of use.
How does leasing differ from conventional
financing?
Compared to conventional financing,
leases, particularly capital leases, may
include 100 percent of the equipment
costs, including installation and other
attendant costs. For many growing businesses, the effective capital management
can have a significant impact on the
growth and success of a business.
For example, assume a business owner is
contemplating a $50,000 piece of equipment used in her production process. Also,
assume the owner can get a loan from her
bank for $37,500 on the equipment, requiring her to invest $12,500 of cash for the purchase. If the effective annual rate of interest in a lease is 9 percent, the lessee must
determine if she can use the $12,500 elsewhere in her business and earn an annual
return greater than 9 percent.
What other sources can companies use to
secure leases?
The growth of lease financing has created
numerous leasing sources, which may
include banks, leasing companies or the
manufacturer of the equipment — either
directly or indirectly via a lease program
with a provider. These sources will have
varying programs that will affect the
amount financed, the payment terms, the
requirements for maintenance, insurance,
etc. The good news for entrepreneurs is
the growth of this type of financing has created numerous alternatives that may be
customized to the lessee’s situation.
In addition, if done properly, the comparison of lease and conventional financing
programs will require business owners to
evaluate their current situation, plan for
the future and optimize their financing
sources to achieve growth at the lowest
possible cost.
MARK HECKLER is group regional president of commercial
services for MB Financial Bank. Reach him at (847) 653-1820 or
[email protected].
