No matter what category of commerce you’re engaged in, your small business almost certainly uses some kind of expensive equipment. Think manufacturing equipment. Specialized tools. Computers and peripherals. Vehicles.
Accounting for the cost of these machines raises a complex series of questions. But one of the top priorities is deciding initially whether to buy or lease.
Fundamentally, leasing lets you limit your cost—and your responsibility—to the value you derive from the machine while you use it. In effect, you’re paying only for the portion of the machine’s value that you consume. When the lease expires, you have the option, but not the obligation, to return it to its owner (the leasing company, or lessor). Usually the lessor will offer to sell it to you for a reduced price that reflects wear. The machine’s post-lease price, established in the lease agreement, is called its residual value.
When you buy the same equipment, your initial responsibility extends to the machine’s full value—including the portion of the machine’s usefulness you haven’t consumed yet. As the owner, you assume responsibility for disposing of the now-used machine (a car, for example) to recover its residual value. You can keep using it until its condition renders it useful only as scrap.
So which option is right for you? That depends on your priorities, the nature of your business, the equipment, and the tax consequences—all of which might warrant a review with your accountant. But definitely take these variables into consideration:
• Tax deduction: In many cases, businesses can deduct the cost of leasing equipment if it’s considered an operational expense. If you purchase the equipment outright, it’s treated differently for tax purposes; you may need to amortize the machine’s value over time, which delays and possibly reduces the amount you can deduct when you first acquire the equipment. But you can often deduct any interest expense if you finance the purchase.
• Upfront cost: Like any other installment financing, leasing lets you pay less upfront but ultimately costs more over time. Buying usually entails a higher upfront cost, even if you’re financing the purchase. If your business is seriously cash-strapped, this factor can affect your operating budget.
• Updates: If you need equipment that undergoes frequent updates, like a computer, allow for the fact that some brand-new machines lose their value quickly. New cars famously lose half their value soon after you drive them off the lot. If you don’t want to be stuck with an outdated machine in a year or two, a lease might make more sense. If you foresee using the same reliable machine over a decade, an outright purchase may be better for you.
• Maintenance and repair: With a lease, you may be required to perform basic maintenance functions, but won’t be responsible for repairs if the equipment breaks or wears out. After all, you don’t own the machine; the lessor does. On the other hand, this factor can work against you. If a leased machine goes down, the lessor isn’t as motivated as you are to get it back up and running ASAP. With mission-critical equipment, you could lose valuable production time. You also don’t control the quality of the service technicians sent to repair the equipment. If you opt to own the equipment, you’re financially responsible for all repair and maintenance, but you also control the timing and quality of those services.
• Residual value: If you lease, one of two things happens when the lease is over: either you no longer have use of the machine and will probably need to replace it, or you must buy it from the lessor for a price stipulated in the original lease agreement. Both of these outcomes can be disruptive. If you had originally bought and financed the machine, your choices would include some combination of: replacing the machine on your own timeline, keeping it as a backup, and selling it to recover its residual value.
• Flexibility: Many leasing companies have the flexibility to tailor the payment schedule to fit your established cash flow. So, for example, if you generate 70 percent of your revenue during the last two months of the year, your lease payments can be pre-set to reflect your cash flow patterns: lower in slack periods, higher during the busy season. Some finance companies offer this option too.
There’s no single definitive answer for all businesses, but these considerations can get you started toward deciding whether to buy or lease. For help sorting through the variables, contact us at Expansion Capital Group or call us at (877) 204-9203. Our small business professionals can help you make the decision that works best in your situation.