August 20, 2018
If your company wants to improve cash flow, you might consider leasing equipment, vehicles and facilities, rather than buying.
The primary advantage of leasing used to be the tax advantages. But the fact that leasing allows you to conserve cash makes it a form of financing. It’s not an alternative that works for every company so you should consult with a professional to help you compare leasing versus owning.
Almost any asset can be leased these days, from aircraft to oil wells, but leasing usually involves vehicles, heavy equipment, computers and other office equipment. Leasing can be a good option if the assets are subject to rapid obsolescence, you want a quick tax write-off, you can’t afford a large down payment, or you don’t want to take out a loan.
However, there are some downsides:
- You don’t actually own the equipment.
- You don’t build up equity.
- You may pay higher interest than on a loan.
- You could wind up stuck with lease payments when your business no longer needs the equipment.
The following are other business implications to consider:
Insurance. When an insurance policy pays out for the destruction of an owned asset, it usually pays the fair market value. But on a leased asset, the payout generally is the amount remaining on the lease or whatever the leasing company settles for. That can be substantially less than fair market value if you made a large down payment or the lease is nearing completion and the asset has been well maintained.
Obsolescence. Leasing can be cost effective when you need assets such as computers and other electronics because the resale value is low and if you buy, you may wind up frequently upgrading and scrapping old equipment.
Ownership. Since you don’t own the asset, you are out of luck if the leasing company pledges the asset as security and it is seized to satisfy creditors. This has occurred when automobile dealerships went bankrupt and the automobile manufacturer re-possessed leased vehicles.
Liability. Leases are often difficult to get out of, and may not be transferable, leaving you liable for continuing payments even if you no longer need the asset.
Residual Value. Leasing companies don’t want to lose money, so they come up with a residual (or future sale) value at the end of the term. You will likely have to pay the difference between that value and the actual value. However, you won’t be liable for the payment if you return the asset in pristine condition so that it’s worth more that the residual value.
Cash Flow. With the exception of a few assets, including automobiles, leasing often requires little or no down payment when compared with a loan. However, effective interest rates for leases are higher than interest rates for loans.
Read the Fine Print: There’s more to leasing than writing off the cost of the lease. Consult with your advisor to determine if leasing makes sense for your business.