Equipment leasing versus buying Featured

8:00pm EDT March 26, 2007
Two questions can help you determine whether to lease or buy equipment. (1) How will the costs of acquiring the equipment affect our cash flow and leverage, and (2) how long will you want to keep the equipment?

“Knowing the answers will help lead you down the right path,” says LaShaun A. Coard, vice president/senior relationship manager, Wells Fargo Bank N.A., in Houston.

“When determining whether leasing is the best option, it’s important to consider which type of lease product best meets one’s needs — an operating lease or a capital lease,” adds Coard. “An operating lease is an off-balance-sheet item. If cash flow or leverage is an issue, you may be able to deduct the leasing expense against current income without showing equipment on your balance sheet as an asset or liability.

“A good CPA will help you determine which financial scenario makes the best sense for your company.”

Smart Business spoke with Coard about leasing versus purchasing.

What are the advantages of leasing?

A clear benefit to leasing is that you may be able to acquire equipment without cash with a lower monthly payment as compared to the payments that would be due under a loan. All related costs, such as delivery and set-up, may be rolled in, so it may be a 100 percent financing option.

A lease is also an attractive option if the equipment will not have a high residual value, becomes technologically obsolete and/or has a relatively short useful life, such as with computers and other IT technologies.

Another advantage has to do with a company’s borrowing capacity. If your balance sheet isn’t really strong, depending on the type and residual value of the equipment involved, a lease may be easier to obtain because the requirements of some lessors can sometimes be more lenient than those of a conventional bank.

What are some disadvantages of leasing?

Overall, the expenses may be greater with a lease, depending on the type of lease product you select, particularly if the lessee decides to purchase the equipment at the end of the lease term. There might be an option to purchase the equipment at the end of the lease; if so, the amount can be based on an assumed residual value or may be whatever the fair market value is at the end of the lease term, depending on how the transaction was negotiated up front. As with some loans, many leases have prepayment penalties or may not pre-paid at all.

What are the advantages of purchasing?

You’ll own the equipment. With regard to high-tech equipment, such as computers that become obsolete very quickly, leasing may be the better option. On the other hand, if you’re looking at heavy machinery with a long, useful life that will have residual value, buying may be a better route.

Your overall costs may be lower by obtaining a loan to finance the purchase price of equipment than they would be by leasing the equipment if you end up exercising a purchase option at the end of a lease.

By owning the equipment, you avoid the risk of having to pay an increased price to acquire the equipment if the equipment retains a high value, which risk you would have in a lease transaction with a fair market value end of term option.

What are the disadvantages of purchasing?

You may have to spend money up front, which can tie up cash. Depending on the type of equipment, you might have to provide a 20 percent to 30 percent down payment. You also take the risk, again using the example of computers, that there will be no residual value when you are finished paying off the equipment — so it will be yours to sell, and you might not get much for it.

Do you have any money-saving tips?

First, as mentioned above, a good CPA will determine how to structure the tax deductions to your best advantage.

Second, if you need to make a major purchase and don’t want to spend cash up-front, another option is interim funding. For example, an equipment manufacturer requires a 30 percent down payment, another third after 30 days, and final payment upon delivery. With Wells Fargo Equipment Finance, Inc.’s (“WFEFI”) interim funding product, WFEFI can make those payments for you, and you only make interest payments during that period. When you take delivery of the equipment, the lease then begins.

What criteria should someone look for in a lender or lessor?

Many vendors have their own leasing deals and will promote discounts if you lease through them. You should compare what they’re offering as a discount to what you can get elsewhere, taking into consideration the amount you have to pay up front, the monthly payment, the term and the endof-term options. Ask what your commercial banker can offer. It’s prudent to have this type of relationship in place. If you look to one banker to handle all your business needs, your banker may be able to make concessions for you. The relationship with your banker can be as important as your relationship with your attorney or CPA.

LASHAUN A. COARD is vice president/senior relationship manager, Wells Fargo Bank, Houston. Reach her at (832) 723-5323 or lashaun.a.coard@wellsfargo.com.