Buy or Lease? What You Need to Know
February 18, 2020
|
Equipment Finance
February 18, 2020
|
Equipment Finance
The buy or lease decision amounts to weighing your risks and opportunities. Is it better to take cash off your balance sheet and own your equipment outright, or should you borrow at a lower rate to reinvest in projects that could yield a higher rate of return in the long run? Are the tax benefits of one better for you than the other?
Whether you decide to lease equipment or purchase it outright, each option comes with its own set of potential opportunities and risks. You can prepare to make the decision by answering a few key questions:
- What is the opportunity cost of capital? That is, can you reinvest the capital allocated for equipment purchases into other parts of the business to generate a higher rate of return?
- What is your interest rate policy? Have you weighed the benefits of adding fixed-rate debt versus using a revolving line of credit with a variable interest rate?
- What is your equipment replacement cycle? How long do you plan to use the equipment?
Acquiring the right equipment can help improve processes and productivity, and even foster innovation. But to get there, you need a plan that addresses both your short- and long-term needs. Consider the following pros and cons for each option.
Purchasing Advantages
- Tax advantages. Under the Tax Cuts & Jobs Act of 2017
, companies can take advantage of accelerated depreciation to deduct up to 100% of the purchase cost, but this causes depreciation to decrease in later years. A company considering the purchase option should evaluate its projections for current and future profits to determine the best time for using this tax benefit, as they might not be as profitable now as they expect to be in the future.
- Flexibility. You own the equipment and can do with it what you please, including selling and replacing it with newer equipment.
- Maintenance. When purchasing equipment, you can maintain it according to your own guidelines.
Purchasing Disadvantages
- Higher initial expense. In the long run, purchasing equipment with cash may be less expensive than leasing, but you’ll have to spend more up front. If you take out a loan to purchase equipment, you’ll typically have to make a down payment and will be responsible for interest payments.
- Less available liquidity. Because of the higher upfront costs, you might have less cash available to reinvest in other parts of the business.
- Obsolescence. Most equipment eventually becomes obsolete, with some types—such as computer technology—aging faster than others. In some cases, you may need to replace equipment earlier than expected, even if you’re still paying off the loan. It also might be difficult to sell outdated equipment by the time the loan is paid off.
Leasing Advantages
- Tax advantages. When a company leases equipment it can deduct the entire lease payment over the term of the lease.
- Lower interest rate. Borrowers can often trade the depreciation benefits to the lender in return for a lower interest rate, which lowers the total cost of the lease.
- Fixed interest rate. Because the interest rate is fixed, you can easily calculate lease costs for the lease term, making budgeting easier and effectively hedging some portion of your interest rate risk. This is especially important during rising interest rate or inflationary environments.
- No upfront costs. You can finance up to 100% of the purchase price instead of making a down payment.
- More available liquidity. Lease equipment won’t tie up your cash, giving you the flexibility to reinvest in other parts of the business to generate a higher rate of return.
- More flexible payment options. You can customize lease terms to match equipment use and life expectancy, as well as your company’s unique needs.
- Easier equipment upgrades. With a short-term lease, you can pass the burden of unloading obsolete equipment to the lessor.
Leasing Disadvantages
- Payment obligation for the entire term. You must pay the lease for the entire term, even if you stop using the equipment before the lease expires. Some leases allow companies to cancel the lease or pay it off early, but these options often come with expensive termination fees. (Some loans also contain fees for paying off the loan early.)
- Potentially higher overall costs. How much you end up paying depends on interest rates, the inflation rate and your opportunity costs.
- Maintenance requirements. Lenders often require you to maintain leased equipment to certain standards, including keeping accurate maintenance records to ensure you comply with those requirements.
Deciding whether to purchase or lease capital equipment is an important decision that has implications for your company’s long-term financial health. So be sure to do your homework and review your particular circumstances with your independent legal and tax advisors before you make your decision.
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The buy or lease decision amounts to weighing your risks and opportunities. Is it better to take cash off your balance sheet and own your equipment outright, or should you borrow at a lower rate to reinvest in projects that could yield a higher rate of return in the long run? Are the tax benefits of one better for you than the other?
Whether you decide to lease equipment or purchase it outright, each option comes with its own set of potential opportunities and risks. You can prepare to make the decision by answering a few key questions:
- What is the opportunity cost of capital? That is, can you reinvest the capital allocated for equipment purchases into other parts of the business to generate a higher rate of return?
- What is your interest rate policy? Have you weighed the benefits of adding fixed-rate debt versus using a revolving line of credit with a variable interest rate?
- What is your equipment replacement cycle? How long do you plan to use the equipment?
Acquiring the right equipment can help improve processes and productivity, and even foster innovation. But to get there, you need a plan that addresses both your short- and long-term needs. Consider the following pros and cons for each option.
Purchasing Advantages
- Tax advantages. Under the Tax Cuts & Jobs Act of 2017, companies can take advantage of accelerated depreciation to deduct up to 100% of the purchase cost, but this causes depreciation to decrease in later years. A company considering the purchase option should evaluate its projections for current and future profits to determine the best time for using this tax benefit, as they might not be as profitable now as they expect to be in the future.
- Flexibility. You own the equipment and can do with it what you please, including selling and replacing it with newer equipment.
- Maintenance. When purchasing equipment, you can maintain it according to your own guidelines.
Purchasing Disadvantages
- Higher initial expense. In the long run, purchasing equipment with cash may be less expensive than leasing, but you’ll have to spend more up front. If you take out a loan to purchase equipment, you’ll typically have to make a down payment and will be responsible for interest payments.
- Less available liquidity. Because of the higher upfront costs, you might have less cash available to reinvest in other parts of the business.
- Obsolescence. Most equipment eventually becomes obsolete, with some types—such as computer technology—aging faster than others. In some cases, you may need to replace equipment earlier than expected, even if you’re still paying off the loan. It also might be difficult to sell outdated equipment by the time the loan is paid off.
Leasing Advantages
- Tax advantages. When a company leases equipment it can deduct the entire lease payment over the term of the lease.
- Lower interest rate. Borrowers can often trade the depreciation benefits to the lender in return for a lower interest rate, which lowers the total cost of the lease.
- Fixed interest rate. Because the interest rate is fixed, you can easily calculate lease costs for the lease term, making budgeting easier and effectively hedging some portion of your interest rate risk. This is especially important during rising interest rate or inflationary environments.
- No upfront costs. You can finance up to 100% of the purchase price instead of making a down payment.
- More available liquidity. Lease equipment won’t tie up your cash, giving you the flexibility to reinvest in other parts of the business to generate a higher rate of return.
- More flexible payment options. You can customize lease terms to match equipment use and life expectancy, as well as your company’s unique needs.
- Easier equipment upgrades. With a short-term lease, you can pass the burden of unloading obsolete equipment to the lessor.
Leasing Disadvantages
- Payment obligation for the entire term. You must pay the lease for the entire term, even if you stop using the equipment before the lease expires. Some leases allow companies to cancel the lease or pay it off early, but these options often come with expensive termination fees. (Some loans also contain fees for paying off the loan early.)
- Potentially higher overall costs. How much you end up paying depends on interest rates, the inflation rate and your opportunity costs.
- Maintenance requirements. Lenders often require you to maintain leased equipment to certain standards, including keeping accurate maintenance records to ensure you comply with those requirements.
Deciding whether to purchase or lease capital equipment is an important decision that has implications for your company’s long-term financial health. So be sure to do your homework and review your particular circumstances with your independent legal and tax advisors before you make your decision.
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