Leasing vs. Purchasing Your Equipment
From mowers and loaders to trucks and skid steers, large-ticket items are must-haves for survival. But choosing the right tool for the trade — at the right price — is just the beginning of the purchasing decision. Sealing the deal comes with an option: whether to lease or purchase.
“There are many factors that go into the decision to lease or to buy equipment,” says Tom Ade, senior vice president of the construction finance arm at GE Commercial Finance. “You have to look at leasing as an alternative form of finance. It's not an either-or situation. When you look at a lease, it's basically a loan with tax benefits.”
The tax benefits associated with ownership remain with the lessor (the financial or leasing institution), and these benefits are used to drive down the lease rate for the lessee (the end user). Mutual benefits of the lessor-lessee relationship come full circle with the transference of the risk of ownership from lessee to lessor. At the end of the lease, the lessor is responsible for the disposition of the asset. Plus you don't end up with out-of-date equipment.
“While it may not be as much of an impact with the hard-iron, heavy-machinery, basic construction equipment like earth-movers, where you don't look at obsolescence as you would with high-tech, there have been some pretty interesting breakthroughs on the turf side of business,” says Ade. “And that's going to continue. So those who are leasing equipment transfer the risk of obsolescence. It gives the lessee the option to turn in old equipment after the lease period and either buy or lease new equipment, because there have been changes in the technology, or innovation in other equipment.”
Instead of what used to be considered strictly utilitarian objects to push dirt or dig ditches, new introductions and next-generation models of equipment offer more to turf and grounds pros than ever before.
“Any time you lease, you're going to guard against obsolescence,” says Joseph Angelo Jr., president and CEO of Lease One Corp. in Lynnfield, Mass. “Plus, you're obviously keeping the working capital intact.”
A NEW ATTITUDE
In 2005, a survey of the Small Business Administration's State Contest Winners' leasing activity showed that the top benefit of leasing cited by respondents was the ability to have the latest equipment. Eighty percent of the respondents agreed that leasing equipment is a good business strategy for meeting the demands of small business.
“One of the beauties of leasing is that, once you get used to the monthly payments,” says Ade, “what you end up with is new equipment every three years, or whatever the lease term is.”
By leasing equipment you know the amount and number of lease payments over the life of the leasing period, so you can accurately forecast cash requirements for your equipment. What's more, lease agreements offer payment flexibility. One example is Angelo's Lease One Corp., which custom-fits its leases to the Boston-area seasonal job flow. “We do leasing for landscapers around here on a seasonal payment plan,” says Angelo. “Their cash flow dries up in the wintertime; they're either plowing or not working at all. So we structure plans for payments for nine months with three months off.”
The Equipment Leasing Association of America (ELA) recommends deciding if leasing is the best option by first understanding your specific needs and asking these questions:
How does this equipment make your business more competitive?
What is the most efficient use of your cash flow to pay for this equipment?
How long will you use the equipment?
What will your equipment needs be in the future?
It is important to understand that leases are not loans. As a result, leasing costs are figured differently from those of loans. Leases take into account that the equipment is worth something at the end of the lease term. This is called its residual, which is built into lease pricing, usually making the lease payments lower than a loan. According to the ELA, to compare lease products, it is better to compare monthly payments than to try to compare loan interest rates with lease rates. On a cost-of-capital basis, leasing may be the least expensive option.
The green-industry merger activity is as proliferate as the need for operating capital for fulfilling large, lucrative contracts. In both cases, leasing may attract financial suitors.
“What is most important for a company's financial statements are growing revenues, profitability and a reasonable leverage position,” says Ade. “From the perspective of a lender or a lessor, when I'm investing in a company — when I write a lease or a loan — I look at whether they're growing their business, if they're profitable and whether they've been reasonable in terms of how they borrow.”
With its low risk, the practice of leasing has become “a very acceptable and effective alternate form of financing,” says Ade. “Though it's not for everyone, there are myriad situations when it is applicable.”
Because an operating lease is not considered a long-term debt or liability, it does not appear as debt on financial statements, thus making a company more attractive to traditional lenders. As business grows and needs change, a lease can allow for adding or upgrading at any point during the lease term through add-on or master leases, a smart move from a lender's viewpoint. (If growth is anticipated, be sure to negotiate that option when structuring the lease program.)
“A landscape contractor needs to have a clean balance sheet,” says Angelo. “One way to have a clean balance sheet is to lease the equipment being used. By having a clean balance sheet, you get a better bond rating; with a better bond rating you get better jobs. Not to mention, equipment can be very expensive. Most can't afford to go out and purchase a $70,000 backhoe.”
When talking about depreciating equipment, a common misconception is that renting or leasing will avoid the sticky tax code and even save money using depreciation schedules. In those general terms, that's not necessarily the case, according to Russell Tollefson, a CPA in Redding, Calif.
“If you rent the equipment, it's a current deduction,” says Tollefson, who suggests that may be the way to go if an 18- to 36-month project is pending, such as a golf course, but not for a long-term acquisition. “A lease, though, can be capitalized and then becomes an asset. Based on the specific lease, the equipment is subject to the same terms as something purchased outright. If it's a closed-end lease, it's the same as a purchase agreement.”
The IRS does not consider an operating lease to be a purchase, but rather a tax-deductible overhead expense. Therefore, you can deduct the lease payments from your corporate income. It should be noted that, under Section 179 of the IRS code, you can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. This is called the Section 179 deduction. You can elect the section 179 deduction instead of recovering the cost by deducting the MACRS depreciation schedule. The maximum Section 179 deduction for 2006 is $108,000.
Tollefson advises to read any lease agreement carefully, and that leasing can be a way of reducing costs if the time period needed for the equipment is less than a normal ownership period. However, leasing equipment without a purchase agreement is disadvantageous because net worth is not allowed to build over time.
There's also the apples-to-apples cost advantage of outright ownership over the long haul. “If you're going to keep the equipment, you should buy,” suggests Gary Capata, CPA, of Capata & Company in Laguna Nigel, Calif.
“Leasing isn't for everyone,” says Ade. “For somebody who wants to hold onto a very long-life asset for a long, long time, leasing probably isn't as advantageous from a financial perspective as someone who is keeping up with technology, who is taking advantage of innovation.
“If you're planning on using a piece of equipment for decades, then you're probably better off buying it.”
Tracy Powell is a freelance writer who resides in Charlestown, Ind.
TEN QUESTIONS TO ASK BEFORE SIGNING A LEASE
The Equipment Leasing Association recommends businesses ask the following 10 questions before signing a lease. These questions take into account the “before, during and after” stages of a lease.
1. How am I planning to use this equipment?
2. Does the leasing representative understand my business and how this transaction helps me to do business?
3. What is the total lease payment and are there any other costs that I could incur before the lease ends?
4. What happens if I want to change this lease or end the lease early?
5. How am I responsible if the equipment is damaged or destroyed?
6. What are my obligations for the equipment (such as insurance, taxes and maintenance) during the lease?
7. Can I upgrade the equipment or add equipment under this lease?
8. What are my options at the end of the lease?
9. What are the procedures I must follow if I choose to return the equipment?
10. Are there any extra costs at the end of the lease?
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