4 Things To Consider When Deciding To Lease vs. Buy Equipment
Frequently investing in the latest equipment can send a business owner into the poorhouse. Luckily, equipment can be leased, which is often a great alternative.
This article will explore the pros and cons of leasing or buying business equipment. We’ll also discuss four considerations, so you can determine which option is right for your business.
Why Think About A Lease vs Buy Situation
Business owners are faced with many decisions, including how to obtain business equipment. Companies often don’t have enough capital to fund equipment purchases. And even if they do, it doesn’t always make sense to purchase it.
While some companies choose to pay cash for their equipment, this option ties up capital. They could face cash flow problems due to this decision.
Many companies choose to either finance the purchase of their equipment or lease it. Ownership of the equipment is the main difference between these two options. With the financing option, the business owner becomes the rightful owner. With leasing, the business owner may be given a choice to purchase the equipment at the end of the lease term.
There are pros and cons to all the options, which we’ll describe in the following sections.
The Pros of Leasing
- Down payments are usually smaller for leasing than for financing. In fact, sometimes, no down payment is required at all.
- At the end of the lease agreement, the business owner can extend the lease, buy it, or return it.
- Operating leases are usually straightforward.
- In many equipment lease agreements, the lessor is responsible for repairs.
- It may be easier for business owners with bad credit to obtain the equipment they need.
The Cons of Leasing
- Leasing is often more expensive than purchasing equipment with cash. The business owner should analyze scenarios with the lease interest rates and the financing interest rates.
- Depending on how the lease is structured, business owners may not realize any depreciation for the equipment.
- It’s possible for the lease payments to outlive the usefulness of the equipment. The business owner must continue to pay or to break the lease, which is costly.
- Under new rules of accounting, operating leases may appear on the balance sheet as a liability. This could alter the credit profile of a business.
The Pros of Buying
- Equipment depreciates, which could lower tax liabilities.
- Business owners are free to use the equipment however they choose.
- Equipment that remains useful after its funding period gives the business owners an advantage. Not all equipment needs to be brand new to be useful.
- For business owners with great credit, the equipment funded with the loan serves as the only collateral. This may not be the case for businesses with less-than-perfect credit, however.
The Cons of Buying
- For loans used to purchase equipment, lenders may require down payments.
- Loans increase the liabilities on the balance sheet, which could adversely affect the ability of these businesses to borrow more.
- Lenders may require collateral beyond the equipment being purchased via the loan.
- For outright purchases, a large sum of cash is needed to purchase equipment, which depletes capital reserves.
- Equipment often becomes obsolete. The resale value of this equipment will also plummet when this happens.
- Businesses are responsible for repairs.
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Our Four Considerations To Determine To Lease Or Buy
We’ve derived four considerations for business owners to determine a buy vs lease decision. When you factor in these four considerations, you’ll understand where your business needs to allocate its capital.
The first consideration is whether you’re looking for growth or concentrating on becoming more profitable. The second consideration is to determine the reason for the business equipment. Third, how often will the equipment need to be replaced? Finally, how much capital do you have on hand?
Each of these will be explored in more detail in the following sections.
What Is Your Focus: Profit or Growth?
If you want to grow your business, you should retain as much capital as possible. This capital can be used to buy assets, which will generate growth. Therefore, leasing is the perfect option in this scenario.
On the other hand, if you want to quickly earn profits, buying equipment may help you achieve your goals. You can choose other financial options at a later period.
At Fora Financial, we provide financing to business owners nationwide. Click here to learn more about a cta-freequote.
What Is The Reason For The Equipment Needed?
Knowing the reason that you need equipment is crucial in determining whether to lease or buy. Heavy machinery is often used non-stop, which makes it prone to failure. Scheduled maintenance can help extend the life of these machines, but it won’t prevent them from breaking down eventually.
Some types of equipment become obsolete quicker than others. For instance, computers may eventually fail to update to future releases of operating systems. Companies such as Microsoft retire support of legacy versions of its operating system after a certain period of time.
Conversely, some office equipment tends to last. While there are technological advancements, businesses often can do without the latest developments. For instance, most business owners are satisfied with copiers they purchased several years ago. They often don’t need anything more than copies with these machines.
Often, businesses can save when purchasing used equipment. For instance, new restaurant owners are known to purchase used fixtures and ovens. Used equipment isn’t always available to lease, however.
At What Rate Will This Equipment Need Replacing?
Usually, if a piece of equipment is likely to last well past its financing, buying it is a better option. Conversely, if it needs replacing due to becoming obsolete or normal wear-and-tear, leasing may be the better alternative.
Lessors often allow business owners to extend the lease or purchase the equipment at the end of the lease. Therefore, if you find a piece of equipment that’s durable and want to continue using it, you have options.
The most difficult aspect of determining the replacement rate of equipment is when considering new equipment. If a piece of equipment has no history provided, you won’t know how to gauge the lifespan of it.
How Much Capital Do You Have On Hand?
Some companies are in the enviable position of having excess capital. These companies have strong business cycles that generate more cash than they spend. This scenario happens with companies that have competitive edges, or as Warren Buffett calls it, a wide moat.
If your business can build capital reserves, you may choose to purchase your equipment without any financing or lease agreements.
An important aspect of keeping too much in capital reserves is you may miss out on certain opportunities. Rainy-day funds are useful, but this shouldn’t be a core strategy. If you have no plans to employ the capital, using it for purchasing equipment may be a wise choice.
Both financing and leasing free up your capital, but leasing often gives you more bang-for-the-buck. Lessors often don’t require down payments, nor do they require collateral. That means more of your capital is available for use elsewhere.
At Fora Financial, we offer working capital funding options for businesses. Get a free quote from one of our Capital Specialists.
Our Final Recommendations
Leasing can be a great choice for small business owners looking to obtain equipment. To determine if it’s right for your business, consider creating forecasts. To do this, you can alter the inputs for various scenarios to see how your model will react. Use the information above to help you determine your inputs.
This forecasting exercise will help you select options that will yield the greatest results. Try to be conservative with your estimates or use worst-case scenarios to stress-test your model. You’ll often find the results surprise you.
When you use several scenarios for your model, you’ll be in a better position when obtaining the funds. Plus, you’ll understand the terms and can structure the arrangement to suit your business needs.
One helpful tool for making calculations is a lease vs buy calculator. If you’re good with using a spreadsheet, you could set up the calculations yourself. Or, you can simply use an online tool.
Frequently Asked Questions
Is it possible to break a lease agreement?
A lease is a contract, and most of them will have provisions that allow you to break the lease. However, these provisions are often expensive, which could negate the benefits received from leasing.
Aren’t there new accounting rules for leases?
The new rules require all publicly-traded companies to record their operating leases on their balance sheets as liabilities. Private companies need to start in 2020.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.