“Should I lease the equipment my business needs or purchase it?” This is the question that all business owners ask themselves at least at one point in time, inevitably. Just like with all business decisions there are trade-offs that come with every decision and that decision’s consequences. At the end of the day every business owner, CFO, or executive is ultimately just trying to maximize profit, right? There are definitive pros and cons of leasing versus purchasing business equipment that is important for you to consider on your next equipment acquisition.
So, let’s dig into it a bit and see what pathway… leasing vs. purchasing business equipment… makes the most sense for your business.
Starting with the tradition equipment purchase; this is what we are all naturally more accustomed to. We find the equipment we want for our business and either finance it or pay cash for it. The equipment becomes an asset on the balance sheet and its depreciation gets expensed each month. When we are done paying it off we either keep the equipment for continued use or sell it. A purchase is pretty straight forward.
1. The overall purchase cost is typically less. When purchasing equipment, usually, the over the cost of the equipment, when everything is said and done, is less than when leasing (keeping in mind this is before taking into account the tax savings that can be realized with true leases).
2. More control. With purchasing you have more control over the equipment. You can sell it at any time or use it for as long as it makes sense for you to do so.
3. IRS Section 179 deduction. With most purchases, the IRS allows you to write-off the entire purchase, up to a certain amount, the year the equipment is purchased. Keep in mind, the equipment must be used for business purposes. This can benefit you if you need a large write-off in a particular year to offset income and decrease tax liability.
1. Your likely stuck with equipment that is constantly depreciating in value year after year and possibly becoming obsolete. It is imperative for businesses to maintain a competitive edge and also stay cutting-edge with regards to the equipment they use. With purchase, you may not be as inclined to replace it quickly, as soon as a bigger and better model comes out, because you have already invested a lot into owning the equipment, not to mention having to find a buyer to purchase your old equipment from you.
2. High initial out-of-pocket costs. It is true, to purchase you either must come out of pocket with cash for the equipment or finance the equipment which usually also comes with a required high down payment.
3. Tax Savings. Yes, with a purchase you can write off the entire cost of the equipment year one but as you will learn with leasing (be reading below) there may be even MORE tax savings that you are leaving on the table if you chose to purchase versus lease.
Now, the big and sometimes perceived to be “ugly” word, Leasing. Leasing equipment for business use may be foreign to some business owners but, in fact, according to Entrepreneur.com, the Equipment Leasing Association estimates 8 out of 10 U.S. businesses lease some if not all of their equipment. So why do 80% of U.S. businesses lease equipment? More importantly, why might you want to lease equipment?
1. Ability to acquire equipment with very little money upfront. Cash truly is “king” in business and every business owner learns this principle very fast. With leasing, many times a transaction can commence with very little out of pocket, as opposed to a purchase which likely requires a sizable down payment. Many leases require a first and last payment upfront, as opposed to a 15%, 20%, 30%+ down payment that may be required with purchase.
2. Ability to replace outdated or obsolete equipment. Whether you are a healthcare practitioner, contractor, transportation company owner, etc. it is imperative to have the most state-of-the-art equipment to keep your company’s efficiency high and competitive edge. Leasing can provide a cost-effective way to update your business’s equipment on a regular base without having too much impact on your bottom line (aka “profit”), nor taking too much cash out of your business’s reserves to get into a new piece of equipment
3. Tax Savings. These two words are the reason why tens of thousands of businesses lease business equipment each and every year; not to mention, many of them being Fortune 500 companies. If you truly are wanting to compare a finance purchase option to a lease option, you must understand the possible tax-saving implications of both choices. With most “true” leases business can write-off the entire lease payment over the course of the term as an expense of doing business, just like they write-off any other expense (i.e. the utility bill). Always consult with your tax accountant prior to signing a lease contract to fully understand the type of lease you are entering and its possible tax savings implications.
Debt to revenue ratios. For some small business owners, this concept may seem a little foreign but for other organizations that have had to apply for business loans and were denied due to too much debt in comparison to their annual revenues understand the importance of keeping their debt within certain margins, first hand. With most true leases, there is no added debt to your balance sheet, so the lease has no effect on your debt to revenue ration other than it is helping from keeping it growing in the wrong direction. Leasing is an important tool by many business owners to keep their bank lines of credit open for when capital is really needed.
These tax savings can be BIG. Here is an example:
1. Say a contractor leases a small tractor that had an original purchase price of $75,000
2. The monthly lease payment is $1,750 on a 5-year term (60 months)
3. The total amount to be expensed by the company over the term is $1,750 x 60 = $105,000
4. This company could have a reduction of revenue subject to income tax by $105,000
5. If the contractor is at a 33% income tax bracket this could equate to $34,650 in tax savings!
1. Overall purchase cost. With leasing, the equipment can end up costing more in the end if you intend to keep it for an extended period of time versus purchasing it.
2. Less control. With a lease, you usually can not just sell the equipment whenever you feel fit to do so. There usually is also language in a lease that mandates you maintain the equipment and service the equipment to a certain acceptable standard (which may not be a bad thing).
Whether you chose to lease or purchase your next piece of equipment for your business it is important that consider the trade-offs to either choice to maximize your business’s bottom-line.