Capital equipment purchases can consume the cash flow of thriving businesses. After shelling out a 20 percent down payment, a company is locked into
months of payments. The dilemma for
many owners, especially in tough economic times, is whether to invest in equipment
at all. Most businesses don’t have a choice
if they want to keep up in a competitive
market.
However, there are options. Leasing is a
flexible, long-term financing solution for
businesses, and banks offer leasing strategies based on how the business wishes to
treat equipment leases on the balance sheet,
its available cash flow and tax motivations.
“Every company leases in some capacity,
whether it’s just a copy machine or a piece
of equipment that is responsible for producing a major product line,” says Andy Beclay,
regional head of equipment finance for
Huntington Bank.
Smart Business spoke with Beclay about
the opportunities businesses can embrace
through leasing agreements with banks.
Why is it better to lease, not buy, equipment?
There are various reasons to lease equipment, mainly for flexibility, to preserve cash
flow, to take advantage of tax-deduction
alternatives and to manage how equipment
acquisitions are treated on the balance
sheet. Probably the most critical driver in
why you would lease rather than purchase a
piece of equipment is to preserve cash flow.
With 100 percent financing available in lease
agreements, you can acquire the capital
equipment needed for expansion or
upgrades without compromising other
aspects of your business, such as payroll,
vendor terms and acquisition opportunities
that require cash in the bank.
What is the difference between an operating
lease and a capital lease?
An important point to keep in mind is that
there are separate guidelines for the tax and
financial treatment of a lease agreement.
These guidelines do not always align with
one another. For instance, it is possible for
a piece of leased equipment to have rental
payments expensed for tax purposes while being depreciated on the financial statements. Generally, if you acquire a piece of
equipment, you capitalize that asset on your
balance sheet. Operating leases qualify for
off-balance sheet treatment, meaning you
do not have to record that asset or the associated debt on your financial statements.
This may appeal to contractors that require
surety bonding.
Another example is to manage leverage or
bond restrictions that might be placed on a
company. Operating leases are also ideal if
you frequently upgrade equipment and
want to use it without ownership.
A capital lease, on the other hand, is treated as a purchase if it meets one or more of
the following criteria: It is classified as a
purchase; the lease term is greater than 75
percent of the equipment’s estimated useful
life; the lease has an option to buy for less
than fair market value; ownership is automatically transferred to the lessee at the
end of the lease term; or the discounted
value of lease payments exceeds 90 percent
of the fair market value of the property.
Talk to your banker about what type of
leasing arrangement makes the most sense
for your company.
How do lease terms compare to a purchase?
Typically, equipment lease terms are
longer than conventional loan terms on
equipment financing. Also, the lessor
assumes a residual position where there is
an end-value to the equipment, and that portion of the equipment cost is not amortized.
Therefore, you are not paying this amount
back during the lease term. This is one reason why leasing is such an advantageous
alternative form of long-term financing for
many businesses.
How flexible are leases in accommodating
seasonal businesses?
Flexibility is the hallmark of a lease, particularly concerning payment structuring.
For example, if you own a contracting business and your busy, high-revenue season is
April through October, your bank can make
arrangements for you to make seasonal payments that reflect your business cycle. Such
arrangements are not possible with typical
bank loans for equipment purchases.
Does leasing open the door for more businesses in tough times?
You have probably read in newspapers
about an overall tightening of credit by
banks given the recent mortgage fallouts and
incidents of foreclosure. In some instances,
banks are being more conservative in their
lending practices. That said, obtaining a loan
for a significant capital expense isn’t exactly
a cakewalk for some businesses. This does
not mean that there are not other options to
help you secure the equipment you need for
your business. Plus, much of the recently
passed economic stimulus package is
designed to encourage equipment investments by businesses. Leasing is an ideal
solution for businesses that are financially
healthy and must invest in equipment or
technology to continue growing. As you consider alternatives to traditional bank loans,
leasing is a viable and, often, more attractive
solution than a purchase.
ANDY BECLAY is the regional head of equipment finance for Huntington Bank. Reach him at [email protected] or
(330) 258-2388.
