Equipment Leasing - Does it make sense for your business?

By Jeff Wright, Senior Vice President, Hennessey Capital

Many businesses are faced with the decision of whether to buy or lease equipment. Each decision must be made on an individual basis. In each situation, the needs of the business and purpose are two important considerations. Is it revenue-producing equipment or can it offer cost savings and efficiencies?

A number of other factors also should be considered before making the decision. One consideration is the predicted lifespan of the equipment. Will the asset be useful for a long period of time or will it be obsolete in the next few years? Leasing may be more advantageous if the asset has a short lifespan while purchasing may be preferable if the productive life of the equipment is longer. For example, computers are an asset where technology advancements render them obsolete after a few years. Leasing may be the preferable option. Service and repair costs should also be considered.

You business’s current cash position must be taken into account as well. Leasing generally does not require a large capital investment or deposit up front. Monthly payments may also differ allowing the business to conserve cash. The related concept here is the opportunity costs. Can the cash saved by leasing be invested in other areas of the business to growth the company?  Therefore, leasing may offer more flexibility and fewer constraints to growth because it requires less upfront cash.

When exploring the benefits and challenges of leasing, entrepreneurs should also examine how the asset is accounted for. When you lease equipment, you do not own the asset and it is not recorded as an asset on the company balance sheet. Payments are recorded as an expense and reduce your profit. The equipment will have some value at the end of the lease. Its estimated value is called the residual value and is generally a percentage of the purchase price. Most leases allow you the option to purchase the equipment for the residual value at the end of the lease. When purchasing, you own the equipment and the asset and related loan, if you borrowed the funds to purchase, are recorded on the balance sheet. The interest cost and depreciation are expensed and impact the profit and loss statement. The interest cost between the two options and method of depreciation should be part of your analysis. 

Be sure to review the lease agreement and consider any cost you may be charged at the conclusion of the lease. Factor in charges for damage or overuse. Are there requirements for providing timely notice for the termination of the lease or penalties for not returning the equipment on time?

The helpful tool for determining whether to lease or purchase an asset is to calculate the net present value. It uses the discounted cash flow, accounts for the time value of money, tax implications, depreciation, and timing of cash flows. The alternative with the lower net present value cost is the most economical. Your CPA can help you with this analysis.