09/ 13/ 2005
by Glenn Townes
As many small businesses struggle to effectively compete in a constantly changing workplace, selecting an effective equipment financing option can be daunting. Choosing to lease equipment is often a wise solution for the penny-conscious entrepreneur. Generally, you can acquire leased equipment in three ways:
- Select and order the equipment, then seek financing through a lessor.
- Select the equipment by working with a vendor or a manufacturer that offers leasing through its own subsidiary.
- Obtain the equipment directly through a lessor.
Determine if you want an operating lease or a capital lease. An operating lease, in a nutshell, is a lease for which the lessee acquires the property for only a small portion of its useful life. An operating lease is most commonly used to acquire equipment on a short-term basis.
A capital lease must meet one of the following conditions:
- The lease life exceeds 75 percent of the life of the asset.
- A transfer of ownership to the lessee occurs at the end of the lease term.
- An option to purchase the asset at a substantial discount at the end of the lease is included.
- The present value of the lease payments exceed 90 percent of the fair market value of the asset. One notable difference between the two is that an operating lease provides a lower cost than its counterpart in its early years.
The cost of leasing is comparable to other financing options when examining the process and transaction. However, the costs associated with leases are figured much differently than for loans. For example, leases take into account that the equipment will have at least some monetary worth at the end of the lease term agreement. This is called residual value. Residuals are built into lease pricing and often reduce the lease payments lower than a loan. It’s easier to compare monthly payments than to try to compare loan interest rates with lease rates.
By signing a lease, the lessee assigns purchase rights to the lessor, who may already own or ultimately purchase the equipment as agreed. When the lessee accepts it and makes certain that the equipment meets all the specifications, the lessor pays for the equipment, and the lease goes into effect.
The Benefits of Leasing
Leasing offers countless advantages over other financing methods for office equipment. The most notable and, perhaps, most appealing of these advantages is a tax break. Others include:
- Tax treatment and tax benefits. The Internal Revenue Service does not consider an operating lease to be a purchase, but rather a tax-deductible overhead expense. Therefore, you can deduct the monthly lease payments from your corporate income. Also, the equipment does not have to be depreciated over a specified period in order to be written off. The tax write-off is immediate. Also, lessors can pass the tax benefits of ownership onto the lessee in the form of lower monthly payments.
- Balance sheet management. An operating lease is not considered long-term debt or liability and does not appear as debt on your financial statements. This makes business owners more appealing to traditional lenders down the road or when needed.
- Total financing. When an individual leases equipment, there is often little or no money down requirements. In most cases, only the first month’s payment may be required. The little or no-money-up-front amenity allows business owners to have more cash available to invest in revenue-generating activities.
- Customized solutions. A lease program can be arranged to meet the specific needs of the entrepreneur, including cash flow, budget, transaction structure and long-term goals. For example, some leases allow a small-business owner to skip a payment or two without penalty, which is a valuable amenity for a small business during periods of slow cash flow.
- Upgraded technology. If the nature of your business demands that you have the latest technology, a short-term lease can help you get the equipment immediately and keep most of your cash. Lease equipment depreciates quickly.
- Improved cash forecasting. Lessees know the amount and number of lease payments and can forecast the cash requirements for the equipment for the duration of the lease.
Finally, at the end of the lease, your options include returning the equipment to the lessor, purchasing it at a nominal fixed price or renewing the lease. The best leasing plan meets the needs of your business on a short-term and long-term basis and understands your options when the lease expires.
