To run a successful business, you might need to purchase a number of big-ticket items. Whether you are in construction and need a back hoe or you’re upgrading your computer system, the decision to acquire is generally easy, but whether to buy or lease is often a tougher question.
When assessing your options, start with a projected cash flow statement showing the benefits of the item and the costs associated with leasing and purchasing. Perform a net present value analysis of your cash flow under both options and compare the results.
Evaluate the advantages and disadvantages of each, focusing on the financial impact on your company.
The advantages of leasing include:
* Reduced initial cash outlay. The main advantage of leasing is that you gain use of an asset with the initial outlay of less cash than would be required to purchase it.
* Easier credit terms. It’s easier to find someone who is willing to lease you equipment than to find someone to extend credit to purchase it. With a lease, the title to the property remains with the lessor. If payments are missed, the lessor can quickly get the equipment back. Also, you may be able to negotiate a longer period and more flexible payment schedule with a lease than with a loan.
* Avoidance of financial restrictions. An equipment lease rarely includes provisions restricting future financial operations. With a loan, the agreement commonly includes restrictions on acquiring additional equipment or borrowing additional funds without the lender’s permission.
* Flexibility in meeting your needs. If you are uncertain about a piece of equipment, leasing it on a short-term basis provides the opportunity to evaluate its utility without committing your resources. Use short-term leases to test and compare brands and models.
* Maintenance support. Avoid having to find qualified repairman and decrease your downtime when repairs are necessary. Many leases include the responsibility of maintaining and repairing the leased equipment in the cost.
The disadvantages of leasing include:
* Overall cost. The biggest disadvantage is that the costs over the life of the asset often exceed the purchase price. This is because rental payments must compensate the lessor for acquisition and financing costs and for the lessor’s retained risk of continuing ownership.
* No ownership interest. Leasing does not establish equity in the equipment. At the end of the lease, you have no tangible asset to show for the expenditure. Negotiating a purchase option, under which a portion of your lease payments is credited to the purchase price, can create equity.
* Lost tax benefits. You lose the tax benefit of depreciation deductions that comes with ownership.
* Commitment to property. Once you sign a lease agreement, you commit to making payments for the entire lease period, even if you stop using the property.
If you decide to purchase the equipment, there are a few things to consider.
* Used equipment. Don’t overlook the second-hand market. You may be able to purchase for a fraction of the cost of new.
* Negotiation of an equipment purchase. Know what you want and what you are willing to pay.
* Tax incentives. Some or all of your equipment’s cost may be eligible for federal and state income tax deductions. The largest tax savings is made by electing to expense a portion of the cost of the item subject to annual IRS limitations, and the remaining expense through depreciation deductions. Consider financing the purchase, as the interest payments are deductible on your federal tax return.
Leasing is often more cost-effective for items that decrease in value over time and that will be used for five years or less, such as cars and computers. For property being used for longer than five years, the long-term cost of leasing will often be greater than the cost of purchasing.
With property that will appreciate, such as real estate, leasing should be considered only as a last resort. Owning appreciating business property is a key to long-term wealth.
Michael J. Voinovich, CPA is an associate director in the accounting and auditing department of Saltz, Shamis & Goldfarb Inc., the tax and accounting division of SS&G Financial Services Inc. (www.SSandG.com). Reach him at [email protected] or (614 )488-3126.