Whether it’s merchandise displays for retail, refrigerators for food service, railcars to move grain, or 3-D printers for manufacturing, every business needs equipment. But how the business acquires that equipment may not always be clear.
“As a business owner, one of the most significant decisions you can make is whether to lease or buy the equipment that keeps your operation running,” says Jim Altman, middle market Pennsylvania Regional Executive at Huntington Bank.
Smart Business spoke with Altman about the key factors to consider before buying new equipment.
How does cash flow factor into the buy/lease decision?
Leasing may improve a company’s cash flow when compared to a term loan or cash option. The primary benefit is that leasing frees up working capital to use in other ways — to grow the business or to invest in marketing or research, for example.
When a company leases, it can acquire equipment and get it installed with minimal initial expense. Buying, on the other hand, requires a significant outlay of cash: Typically, a company can only finance up to 80 percent of the purchase price or hard costs.
Leasing may allow a company to get more expensive equipment than what it could otherwise afford. With leasing, there is also the opportunity to incorporate within the lease some soft costs, which could include training, software and installation costs.
What should companies understand about upgrades and appreciation?
When the lease is up and the equipment is out of date, the company simply leases new, updated equipment. Some equipment can become outdated even before a lease ends, so before entering into a lease, it’s a good idea to find out if the equipment can be upgraded early.
A company might, however, consider buying if it plans to use the equipment longer than five years and if the asset is expected to appreciate in value. In this instance, the company is in a position to gain equity in the equipment as it pays down a traditional term loan. Owning equipment outright also gives companies the option to customize it, sell it or trade it as business needs change.
Which is the better option when flexibility is desired?
Leases are usually easier and quicker to obtain and have more flexible terms than traditional term loans for buying equipment. A company may be able to close on a lease of up to $500,000 in just a day or so. Companies may also be able to bundle multiple pieces of equipment from different vendors into one lease, and, by doing so, they can get a lower overall cost.
Further, today’s accounting guidelines allow for some equipment leases to be ‘off balance sheet,’ which means they don’t show up as debt or liabilities on a company’s balance sheet. That means the equipment acquisitions aren’t tying up the company’s debt capacity.
What are the tax implications of the two options?
When a company leases equipment under a fair-market-value lease, it has the option to return the equipment at the end of the lease term with no obligation. For tax purposes, a fair-market-value lease means that the company can deduct the full amount of its annual lease payments.
The IRS allows companies to write off certain equipment purchases every year. Buying equipment also creates the opportunity to realize some tax savings through depreciation.
When deciding whether to lease or buy, companies should consider their ongoing needs for ready cash, how frequently they may need to upgrade, the impact on their business’ balance sheet, and be sure to check with a tax adviser in order to fully understand the tax implications of leasing and buying.
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