Each year, American businesses, nonprofits and government agencies invest over $1 trillion in capital goods and software (excluding real estate) of which 55 percent ($550 billion) is financed through loans and leases. In fact, 80 percent of U.S. businesses use leasing as a form of equipment financing.
Should you buy the equipment you need with cash, or should you take out a loan or lease the equipment you need? These are the questions business owners are asking now that the economy is showing some signs of improvement.
“Small businesses often have difficulty raising capital that’s no secret,” says Jeffrey J. VanCleve, president of FirstMerit Equipment Finance Inc. “This difficulty, among other reasons, has caused many to look at leasing equipment as an alternative financing arrangement for acquiring the use of assets. All types of equipment leasing, including motor vehicles, computers, manufacturing machinery and office furniture, have become more and more attractive.”
Smart Business spoke with VanCleve about the advantages of leasing compared to the other types of purchasing equipment.
What’s the difference between a lease and a loan?
An equipment lease is an agreement allowing a business to acquire and use equipment, while conserving cash and existing lines of credit. The customer (lessee) makes periodic payments to the equipment finance company (lessor) over the lease term, and the lessor holds legal title to the equipment. Leases are generally written to allow the customer to purchase or return the equipment at the end of the lease term.
On the other hand, an equipment loan is an agreement advancing funds for the customer to use to purchase equipment. The customer (borrower) makes periodic payments of principal and interest to the lender over the loan term. The customer owns the equipment and holds legal title; the lender takes a security interest in the equipment until the loan is repaid.
What are the advantages of leasing?
Although there are many individual advantages to leasing equipment versus purchasing with cash or financing with debt, these advantages can be placed into four categories:
- Leasing improves cash flow: leasing provides 100 percent financing for your equipment acquisition, while loan financing often requires a cash down payment. A lease allows a business to conserve cash for other strategic needs. Also, lease payments are typically lower than loan payments, enhancing monthly cash flow.
- Leasing improves profitability: monthly lease expense is typically less than the combination of depreciation expense and the opportunity cost of capital (with a cash purchase) or depreciation expense and interest loan expense (with loan financing). Lower financing expense means greater profitability.
- Leasing reduces risk: a lease typically transfers the obsolescence risk of depreciating equipment to the equipment finance company, while providing a business with the flexibility to either purchase or return the equipment at the end of the lease term.
- Leasing optimizes available tax benefits: there are tax benefits associated with new equipment acquisition and ownership. Leases are typically structured to take optimum advantage of those benefits, providing the lowest after-tax cost to the end user customer.