There are many sound reasons for reviewing the equipment lease option. First, when a company decides that a MART Power Washer or other equipment is a worthwhile investment but lacks the funds to make the acquisition, leasing may prove to be a viable solution. Next, a review of leasing can reinforce the funding decision already made. The third reason for the review is that the leasing cost can be expressed as a cost per day, which allows for an easy comparison of the value of competing equipment. A $1,000 increase in the purchase cost, amortized over five years, only raises the daily investment by $1. And the higher lease cost is often offset by lower operating costs. This can be determined by completing The Parts Cleaning Cost Analysis form.
Since each company’s financial position, tax picture, business objectives, profit goals and cash flow are different, no set decision making rules apply. The advantages of leasing should be considered in light of the company’s activities and should be discussed with the financial advisor. MART discourages talking to bankers about leasing options since it is not usually in the banker’s best interest to recommend an equipment lease.
Leasing is now a $220+ Billion Industry Nationwide
Leasing is designed to produce profit through the use of equipment rather than ownership. A lease is a contract by which the company obtains possession and unrestricted use of equipment for a specified length of time at a specified lease rate. It is pay-as-you-go financing if the purchase option is exercised at the end of the lease period.
To be a sound investment, the lease payments should come directly from the added profits or operating cost reductions generated by the use of the equipment.
Three reasons for leasing
- Keeps capital free for other promising investments
- Allows better use of existing credit lines
- Lease payments are 100% deductible from pretax income
Payments are usually Fully Deductible as Current Business Expense
For accounting and tax purposes, lease payments are rentals and are deducted from pre-tax income rather than after-tax profits. The personal property taxes that the lessee pays at the end of each year are also tax deductible. Leasing provides intermediate term capital without the costly credit support of compensating balances. Thus the company’s cash is not tied up.
Leasing does not require an equipment deposit and can even be set up without a down payment. Charges such as spare parts, freight, installation, technical assistance and training, and supplies can be included in the lease to further conserve capital funds. Lease payments tend to be lower than conventional financing since the terms can be extended to more closely reflect the useful life of the equipment.
Lease payments can also be made flexible to allow for seasonal peaks. For example, if the company historically does more business in the summer months, lease payments can be higher in these months and lower the rest of the year.
Leasing does not weaken the Company’s Borrowing Position
The bank credit line remains the same because no money is borrowed, and the lease does not appear as debt on the financial statement. It preserves the use of credit sources by conserving the existing credit lines.
If, for example, the company has a $200,000 credit line and borrows $50,000 for a new MART Power Washer, then its borrowing ability would be reduced to $150,000. By leasing the Power Washer the company retains its bank credit line for short term financing and daily operations. Quite often a company can qualify for a lease, even when its capital limit with the bank has been exhausted.
Leasing Resists Inflation
The monthly payments are set at a fixed rate and cannot increase during the lease term. In fact, the reverse occurs because inflation reduces the value of the payment in real terms over time. At the current rate of inflation, a $300 lease payment will adjust to a future value of $200 in five years, and a $5,000 buyout option will adjust to about $3,400.
Lease Payments can be made from the Operating Budget
Public companies and government entities of all kinds, and many privately held companies, have difficulty budgeting for capital equipment expenditures. Even when the purchase is approved, mid-year budget cuts can push the purchase aside for another year or more. In such cases, making the lease payments from the operating budget is appropriate because the lease and equipment acquisition can be finalized more quickly.
Why the urgency to acquire the Power Washer? Simply because the investment does not begin to pay off until the equipment is installed and operating. Suppose management determines that a $50,000 Power Washer will eliminate one employee costing $30 an hour in the parts cleaning department, but there are no capital funds available for this purchase. The lease investment, based on a 13% (.02262 factor) cost of money over five years, is $1,100 per month or $52 a day. In other words, for a daily investment of less than $55 a day from the operating budget, the company can eliminate a cleaning position costing $240 a day, and the employee can be reassigned to productive work. The savings reduce the operating expenses which drop to the bottom line as profit.
Further, at the end of the lease term the Power Washer can be purchased for about $5,000. It is far easier to budget for the $5,000 buyout five years in the future, than to budget the capital expenditure of $50,000 for an outright purchase now.
Also note that management can make these decisions and acquire the Power Washer immediately, rather than wading through the time consuming capital budget approval process and possibly waiting years to purchase and benefit from the equipment.
The above scenario holds true for one and two man shops as well. The monthly investment for a loaded CYCLONE 30 Power Washer costing $20,000 is $445 a month, or $21 a day. The Power Washer pays for itself by saving just ½ hour of shop labor each day. Clearly, it will immediately begin paying its own way and showing a profit, from the day it is installed.
Leasing enables Management to Equip a New Facility
Too often a company, in the throes of a major improvement, runs short of funds. Buildings get built – with offices and furniture and computers, and other managerial and operational trappings – but the funds that remain are not sufficient to purchase the equipment that enables the investment to pay off.
Leasing is one of the many alternative means of acquiring the equipment necessary to cost effectively run a business. It is not the best funding source in every instance, but management will only know for certain if it figures its acquisition options in all possible ways.