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.
How can leasing equipment help with your business’s cash flow?
If you are running a business, you may be struggling with current and future business conditions; however you need to replace some equipment now, and could use some new equipment to accommodate planned future growth.
The short-term uncertainty makes it even more important to run your business as efficiently as possible, and have the ability to take advantage of growth opportunities. New equipment in your planned capital expenditures may be critical in delivering the performance improvements you need in 2011.
New equipment often provides a tangible cash flow benefit in increased revenue, lower costs or improved productivity, but these cash flow benefits are derived over time. Financing new equipment through a lease allows better matching of future cash flow benefits with financing payments, thus cash can be retained in the business in these somewhat uncertain times.
Why is it important to keep cash on hand?
You may believe (and you wouldn’t be alone) that if you have the cash available in your business to acquire necessary new equipment, you should always pay with cash, because it is less expensive than financing the equipment through a bank or equipment finance company. However:
- It is important to ensure that your business remains liquid and has plenty of cash available to manage through any setbacks.
- A business can fail because of a shortage of cash, even while showing accounting profit.
- Often the greatest opportunities to grow/expand appear in times of market turmoil. It takes cash to take advantage of opportunity.
Where can a business turn for help?
An equipment financing and leasing specialist can structure a financing solution that optimizes your business cash flow while meeting your accounting and tax objectives. Interest rates are low and lenders are eager to help in this area. Ask your banker if you can discuss financing alternatives with their equipment-financing specialist, and keep cash as king of your balance sheet to better manage your business.
Jeffrey J. VanCleve is president of FirstMerit Equipment Finance Inc. Reach him at [email protected] or (330) 384-7429. FirstMerit Equipment Finance provides equipment financing and leasing solutions to a broad spectrum of industries throughout the Ohio, Pennsylvania and Illinois regions, and is among the top 100 leasing companies in the U.S. with specialized knowledge in aircraft, manufacturing equipment, transportation, medical equipment and municipal finance. With a team of experienced professionals, we provide our clients creative lease and loan structures to meet their financial objectives.