Managing your business

Top Reasons Why Companies Lease And Finance Their Equipment

By: Kate Samano December 30, 2020

Should a business lease or buy equipment? Well, it is a question that does not have a specific right answer. The truth is, it depends on the situation. Equipment loans may help businesses to acquire machinery they need for daily smooth operations right ahead. Business equipment financing may sound too complicated for many, but it may be a worthwhile long-term investment for your company with the right implementation.

To help you gain a better understanding of equipment leasing and finance, you may want to look at such a crucial investment from every. Consider online platforms like Lendzi, where experts will help you choose the right path and help you know more about equipment loans.

Equipment loans vs. equipment lease

Companies apply for equipment loans and pay for the acquisition of assets right away, having complete ownership and control over those items. It means they will only be liable to the lender to repay the outstanding amount. Whereas, in case of equipment leasing, a company lacks ownership of an asset. Instead, the business incurs monthly expenses qualified as operating or finance lease expenses.

Whether your company needs an equipment loan for an outright acquisition of an asset or lease it, we will conduct an in-depth review of the pros and cons of equipment leasing and financing.

Pros

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Less initial expense

The primary advantage of small business equipment financing is that it allows you to acquire assets and reflect in your statement of financial position, but leasing allows you to acquire it with minimal initial expenditure. Because equipment leases do not usually require a down payment, this is a favorable condition, especially for small businesses, and will not affect their cash flow.

Easier to upgrade machinery

Machinery finance through leasing also makes it easier for borrowers to address the problem of obsolescence. For instance, in the case of industrial equipment financing through lease option, whenever you acquire items that may be outdated in a short period of time, the lease agreement passes the burden to the lessor. You will be free to lease new and fresh equipment after your lease expires.

Flexible terms

Most often, leased machinery is more comfortable to obtain and have more flexible terms compared to buying equipment. Equipment loans are a significant advantage for those who have lower credit or not enough retained earnings. Businesses can negotiate terms of the loan by extending maturity and decreasing their monthly repayments.

Tax-deductible

Usually, lease payments can be deducted on a tax return form as a business expense, reducing the net cost of your lease. It means you will also be able to save money while leasing equipment.

Cons

The Pros and Cons of Equipment Financing

Pros

Businesses of all sizes can leverage equipment financing to purchase heavy machinery and other expensive equipment that they could not otherwise afford to buy outright. Even if a business has the capital to buy the equipment, financing the purchase can reduce the strain on cash flow and ensure the company has the funds to meet operating expenses in the near future.

Since equipment financing can be handled online and the process can be completed in as little as a few hours, businesses can gain fast access to the cash they need to make critical infrastructure purchases. Plus, the equipment itself usually stands as collateral for the loan, which means companies and signers aren't putting their homes or other business assets at risk.

Companies can also reduce their tax burden by adding interest charges and the cost of the loan to operating expenses.

Cons

Equipment financing, however, is not without potential downsides, and these should be considered before applying for a loan. Perhaps the biggest issue is that equipment eventually becomes obsolete. If the loan is extended too long, the equipment might not be of use before the funds are fully repaid. The business may find itself making a choice between dealing with old and ineffective equipment or funding the purchase of new equipment while still making payments on the old loan.

Another disadvantage is that equipment owned by a company may depreciate, meaning that as time passes, the amount a company can deduct on its taxes is reduced.

More expensive than buying equipment

Leasing an item ends up being more costly than purchasing it. For instance, consider a 3-year lease on an item worth $4,000, at a standard cost of $160 per month, you will end up with a total value of $5,760, which will exceed the cost of an item. If you have bought it outright, you would have saved $1,760. Undoubtedly, many businesses go for leasing as they want to split their repayments, so they do not have a significant cash outflow immediately. For that purpose, the business needs to identify which option is better than ruining its smooth operations.

The Company does not own the asset in case of leasing

If you choose a company to apply for an equipment loan and pay for an asset right away, it will be reflected on the company’s balance sheet as an asset. However, in the case of leasing, the business incurs expenses but does not have that item as an asset. The good thing is that there was a recent change in international financial reporting standards (IFRS). According to newly established IFRS 16, leased equipment may be reflected on a company’s balance sheet as a right of use (RoU) asset if it meets certain criteria. Many businesses view a lack of ownership as a significant disadvantage because they want to increase their company’s fixed assets and reflect on their financial position. If the statements are prepared per international financial reporting standards, they can ask for professional help to understand whether the business’s leased equipment qualifies for the right use (RoU) asset.

Obligation to pay entire lease term

Before making a lease agreement binding, consider whether it is cancelable without extra fees or not. Some lessors may require you to pay for an entire lease period, even in case you cancel the contract. And there may be some cases where you can cancel the lease if your business needs more upgraded or new equipment. In any case, consider that termination fees most often apply to the early cancellation of a contract. Ensure your company will not incur additional costs for canceling the deal, it may lead to extraordinary expenses reflected in your income and cash flow statements.

Wrapping Up

When choosing whether to buy equipment through equipment loans or lease a particular asset, try to understand the approximate net cost of that fixed asset. Make sure to take into account tax breaks and resale value when making such calculations. After determining which method is more cost-effective and will bring more value to your business, consider other impairment fees such as the possibility that the product may become obsolete (if you are acquiring and not leasing).

In case of leasing, consider that the product may expire before the lease does, and for that reason, you may incur additional costs of termination of the contract. Whichever method you choose, always take into account the future cash flows of the company. Surely, you cannot predict extraordinary events such as damage to the product due to employee misuse or other things. Try to identify whether your business may take advantage of more liability. At the same time, fixed assets on a statement of financial position or having a lease expense without reflecting fixed assets will be more beneficial.

If you are unsure what will be more favorable, consider contacting business consultants who will help your business choose the right path and make growth-based decisions.

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