Businesses need assets — automobiles and equipment. In the past, if you needed
equipment and furniture, you bought it. Today, however, it may make more sense to
lease, what with cash-flow dwindling. Leasing can offer distinct advantages over a loan:
• with a lease, you make payments for a set number of years, then either walk away
from the piece of equipment or pay a lump sum to buy it.
• leases require minimum down payments, if any, and the monthly payments are
probably lower than with a bank loan.
• depending on the type of asset and the term of the lease, the final cost of
acquiring a leased item may also be lower than with a loan.
The reasons why leasing has its financial attractions comes from the fact that leasing
companies buy in volume and therefore get discounts that can be passed on to customers
in a competitive marketplace, and the leasing companies enjoy greater benefit from the
tax rules than small businesses.
The first step in evaluating the economic differences between leasing or buying is to take
a look at the consequences of borrowing money to buy — an analysis that may be useful
to you anyway. Many of the costs of ownership are incurred over several years so the
time value of money must be considered. One thing to remember is government gives
and government takes. What may now be the tax treatment of interest and depreciation
costs may change tomorrow.
A lease is a form of rental agreement — with a lot of potential complications. The lessee
(you) arranges a lease with the lessor (the leasing company) who buys the equipment and
delivers it to you, keeping legal title. There are two types of lease — operating or capital.
In an operating lease, the leasing company generally pays the costs of maintaining and
insuring the equipment and includes a factor for this in the lease cost. In a capital, or
financial lease, you pay these costs.
Other variables to take into consideration are whether you are required to buy back the
equipment at the end of the lease, whether there is any investment tax credit for the
purchase of capital equipment, the depreciation base, and a down payment.
Capital leases come in three styles — closed-end, open-end, and lease-to-buy.
In a closed-end lease, you simply walk away at the end of the lease; however, there could
be “depreciation adjustment” clauses allowing the leasing company to levy a charge if
the asset is returned with excessive wear. If it is a vehicle, the pre-set mileage limit may
have been exceeded.
In an open-end lease, you have the option of walking away or buying at the end of the
lease for a pre-determined “residual value”. You guarantee the leasing company this
value. If they can only sell it off at a lower price, you are on the hook for the difference.
If they can get more, you get a bonus. The higher this residual value, the lower the
monthly payments.
This buy-back option at the end of a lease gives you an out to get rid of bad equipment or
take ownership of good equipment with many years of use left. In exercising the buy-back option, you will have to make a new service contract arrangement. You can also
negotiate a mandatory buy-back where you guarantee the value of the machine at the end
of the lease. By accepting this liability, you will reduce the lease cost further. Another
way to reduce the monthly payments is to make a down payment at the outset of the
lease.
More people choose open-end leases because there would appear to be more complete
disclosure with this kind of lease arrangement.
In a lease-to-own arrangement, you are paying a higher amount than in any other form of
lease, but probably less than a bank loan. This is because of the volume buying of the
lessor, their lower cost of financing, and their depreciation rules advantages. Careful
comparisons with other forms of leasing or borrowing are a necessity due to the higher
cash-flow drain.
The evaluation of the alternatives is not a simple comparison of cashflow requirements
(see also the section on Leasing or Buying Office Space?). The computation of the
economic variables affecting the decision might be best done by your accountant.
Generally though, the higher your tax bracket, the more likely it is you should consider
buying.
There is a computer program called L-B_EQU.WKS which lets you evaluate the
economic impact of leasing or buying. Appendix II explains how this program works.
There are also philosophical reasons for and against leasing. These are reviewed, along
with the impacts on your financial statements, in the Leasing or Buying Office Space
section.
The lease-buy decision for each piece of office equipment should be approached
separately as summarized below. The X denotes which is the suggested financial
arrangement. This analysis assumes you will use the same piece of equipment for a
reasonable period of time. If you are the kind of person who likes to always have the
most recent model, leasing may offer greater flexibility for constant upgrading.
OWN LEASE-TO-OWN LEASE
Phone system X X
Mobile phone X X
Paging system X
Answering machine X
Copier X
FAX X
Typewriter X
Dictation equipment X
Postal machine X
Shredder X X
Overhead projector X
Computers X X
Computer peripherals X X
With technology changing, leasing may let you off the hook when you want to upgrade.
However, the obsolescence factor has been built into the cost. There is a difference in the
meaning of obsolescence to the leasing company that is taking back the piece of
equipment it cannot re-lease, and the obsolescence of a piece of equipment with more
years of use left in it. In other words, there is design obsolescence and functional
obsolescence.
Most leasing companies are now building in flexibility to their agreements. The six-
month upgrade clause means that if you wish to upgrade the machine after six months,
there is no lease buy-out charge; conversely, if you wish to keep the equipment, the
remaining lease payments are reduced. Look for clauses in the lease agreement that
specify the upgrade or buy-out costs at certain points during the life of the lease. Try and
negotiate that these be a percentage based on the current, or last, selling price of the
model, as prices keep coming down. Your lease should also allow for “field upgrades”,
which permit you to add component upgrades to the equipment without having to
terminate or renegotiate the lease.
Finally, look at what your major carrier uses in the way of office equipment. It may be
possible to obtain the same terms and conditions in your lease for one unit that they got
for a thousand by leasing the same thing.
