Should I Lease or Buy with Equipment Loans?
January 03 2021
When establishing their companies, business owners will most likely take out equipment loans to obtain the very best machinery and assets for their operations. Before taking out the loan, they must decide whether it is better to buy the equipment outright through financing or to lease it instead. It is necessary to understand and distinguish the differences between the two and the applications they possess to aid your business’s operations before making this decision. In this article, we look at both terminologies and assess whether buying or leasing expensive assets is the more cost-efficient option for your business.
Before deciding on whether to lease equipment or to buy using equipment loans, there are a number of self-reflective questions that need to be asked beforehand:
What is the nature of our business? Does it involve production, manufacturing, transport, construction or any other type of work?
What equipment do we use? How long do we use it for? Should we buy new or used?
As technology is ever-changing, how do we keep up and invest regularly in the most modern equipment that will keep us ahead of competition and maintain our service standards?
If we buy new equipment, the warranties or service contracts will expire after a certain period. Could this be more costly in the long run?
How can we invest in equipment with flexible finance options to suit our project terms, as most of our contracts are 2-year terms and the equipment needed is project specific?
Are manufacturer / distributor options available and how can we leverage off their market strength and reputation to combine their products with a finance plan?
Your answers to the questions above will determine how you need to proceed when deciding whether to lease or buy (with your own funds or through equipment loans). It is strongly recommended that you assess and explore all the options before making a final decision.
Having the right amount of cash to make an outright purchase can be the easiest and simplest approach. However, this is not recommended as it has the potential to impact your cash flow at a later stage. Every company needs good cash flow as ‘cash is king’ for any business. Whether you finance your equipment by leasing it or taking out equipment loans, either way, the cost is spread out over a certain period of time and will increase the total amount you pay for the use of the equipment.
Both equipment financing methods have their own advantages, where one approach might be favoured over the other. That being said, let’s take an in-depth look at the different types of leasing to gain a better understanding:
Operating Lease vs. Capital Lease
There are two main methods of leasing - an operating lease and a finance/capital lease. Their uses and how they can each benefit your business depends on the answers you provide to the questions asked in the beginning of this article.
Operating Lease: This lease allows you to rent equipment for a set period of time through a long or short term rental. You will never be able to own the equipment with this approach, but you will have the option to use and return the equipment at the end of a set period. An operating lease is considered to be the more cost-effective approach because ownership remains with the lessor who is responsible for the upkeep and maintenance of the asset - this is usually factored into the monthly rental payment to cover the depreciation cost and protect the longevity of the equipment. Your accountant can assist you in the treatment of operating leases to keep your accounts in line with the new IFRS 16 standards, as the rental time period now has different treatment actions.
Finance Lease or Capital Lease: This lease is similar to business equipment loans as you are able to acquire the equipment at the end of the lease term by paying a nominal fee to the leasing company. With a capital lease, the equipment is treated for tax purposes as though you have purchased it and will appear on your balance sheet during the term of the lease. With a finance lease, the leasing company would partner with a number of select manufacturers or products and brands - often with a ‘finance package’ - to present you with different undertakings or options at the end of the lease term. These options usually offer upgrades or buybacks so that you can replace the equipment you have with the latest models and technology. The lease term is for the majority of the asset’s economic life - even if the title is not transferred.
Generally speaking, leasing any given piece of equipment can be slightly more expensive than buying it outright. Nevertheless, leasing is the most popular method of financing in the world and, despite the cost difference, there are many good reasons to lease if it falls in line with your business objectives. As a final piece of advice, it is always good to bear in mind the following:
An operating lease can be applied to equipment that run the risk of becoming obsolete before the end of their usable life, provided the lease term isn’t longer than the expected usable life.
Always consider the length of the lease term, as you may be forced to pay a hefty early termination fee to break your lease if your business suddenly needs to adapt to market dynamics or if new or different equipment is needed.