When it comes to acquiring equipment for your operation, there are a number of choices, and a number of opportunities and pitfalls. The most clear choice is to purchase it outright with cash, but business owners may also use an equipment loan to finance equipment over a number of years. Alternately, leasing provides options to add equipment for a short or long period of time, and has benefits in industries undergoing high technological change.
For well-heeled business owners, cash purchases may be the go-to, but even so, some form of financing or leasing may be a better option. Purchasing equipment with cash, especially when a business is looking at technologies or machinery that starts at $100,000 and extends into the millions, depletes funds that can be applied to operating costs.
There are more factors than just the purchase price and its impact on cash on hand to consider.
Tax Implications – Owned equipment is most often depreciated. Depreciation allows businesses to deduct a portion of the equipment cost from their revenue according to a set schedule. Often this occurs over several years, lowering the owner’s tax burden a bit each year. On the other hand, traditional leasing is treated as a common expense for tax purposes, directly decreasing the owner’s revenue by the amount of the annual lease payments made. This can make leasing advantageous from a tax perspective over the short term. However, if the equipment can be owned and used for many years, ownership could cost less than leasing in the long run even when factoring in the tax implications.
Repairs and Maintenance – When a buyer purchases equipment either directly or with financing, they must cover the cost of repairs, maintenance, and downtime. A leasing agreement often requires the lessor to cover these costs and provide a replacement in the case the equipment fails, helping businesses maintain consistent operations and revenue month to month.
Upgrades and Innovation – When a business buys technology outright or with financing, they need to consider how long the technology will be in use. Imaging systems get better year after year. For many businesses, that means purchasing and replacing may be costlier than leasing in the long term. Land-moving equipment, on the other hand, sees much less innovation and can serve for decades. Understanding your industry and your equipment lifecycle thus becomes an important consideration.
With these factors in mind, let’s take a look at financing and leasing in more depth. We will close with a consideration of how businesses can address end-of-use lifecycles with the equipment they choose to purchase.
Equipment loans are used to buy commercial equipment and technology. They help businesses manage the upfront equipment cost and get tech into their workflow faster. Loans have some benefits over leasing and some downsides. One critical question to ask yourself when deciding whether to buy or lease is how long you expect to use the equipment. Do you see your business upgrading to new technology in the next five years or relying on the same machinery for the next ten?
Loans are the answer when you’re looking for long-term equipment. Here are a few of the benefits of getting an equipment loan:
●You own it. When you own the equipment, you can modify it, use it any way you like, and sell it whenever you care to.
●Tax benefits. You can generally claim depreciation for the equipment on your taxes while also writing off the purchase price.
●Lower operating costs. If you have profitability goals for your business, a loan is the way to go.
There are a few disadvantages to getting an equipment loan. Be sure to consider these and ask your broker if you have questions.
●Down payment. Equipment loans require a down payment. The amount varies by lender. An equipment loan through the SBA has one of the lowest down payment requirements at a 10% minimum.
●Outdated risk. There’s always the risk your equipment will become outdated before your loan term. Some industries rely on the same equipment they have for centuries. Others move fast, incorporating emerging technologies as they become available. If you upgrade regularly, consider the role of depreciation to determine if owning delivers the best value for money.
Leasing equipment is another option, and a very popular one. Like equipment loans, leasing helps you acquire equipment for your business quickly. However, leasing allows you to be more flexible. If you expect to upgrade or replace the equipment within the next five years, a lease is your answer. Let’s take a look at the pros and cons:
In addition to flexibility, here are a few of the advantages that leasing equipment can have over a loan:
●Low to zero down payment. Leasing is almost always the less expensive option when it comes to the down payment, and many don’t require a down payment at all.
●Credit requirements. Equipment leases are easier to qualify for than loans, making them a great choice if your credit score has taken a hit or two.
●Conserve cash flow. When your business goals focus on growth over profitability, a lease is the best choice.
Just like equipment loans, equipment leases have downsides too. Here are a couple of disadvantages leasing can come with. Your broker can give you more details.
●You don’t own it. That means you can’t claim the same tax advantages you’d get if you did. This also means you can’t leverage its equity either.
●You’re in a contract. You can’t sell the equipment when you’re finished with it, and you still have to pay out the lease. You may also have to pay for damage to the equipment. Being properly insured for theft or damage may be costlier for leased equipment, so be sure to evaluate coverage as part of your formula.
Leasing also provides a number of options as to what occurs at the end of the lease term, and how you account for the money you put in.
A $1 buyout lease, otherwise known as a capital lease or equipment finance agreement, allows you to purchase the equipment at the end of the lease for a small fee, most commonly $1. In this approach, you treat the purchase as an asset rather than expense, applying depreciation as you would to any other owned long-term asset. The upside is no down payment, and all interest is rolled into monthly costs – and you own the equipment from day one. The leasing agent does not take responsibility for maintenance or repair.
Fair Market Value leases provide an option to purchase the equipment at the end of the lease agreement or to extend the lease. In this structure, the lease payments are an expense until you purchase the equipment, then you depreciate based on the fair market value. This lease also provides 100% financing, unlike many equipment loans.
Traditional Leasing provides 100% financing and lasts for a set period of time with no purchase option. Costs are treated as expenses on your balance sheet and are deducted from taxes in the traditional way.
In addition, a discussion of equipment financing wouldn’t be complete without touching on the sale-leaseback option. This is an option for businesses that have equipment already and need financing for other projects. If you want to have more flexibility or to reintroduce a capital infusion, choose a sale-leaseback:
●You get capital. In a sale-leaseback, you’re selling your equipment. You’ll get a lump sum based on its market value. However, a sale-leaseback is unique in that you can still use your equipment.
●You keep the equipment. To retain the use of the equipment, you’ll lease it back from the buyer. For a monthly or quarterly payment, you can keep using it under the terms of a lease, without having to move the equipment anywhere.
When it comes to equipment financing, you have a lot of options. They’re not all good or all bad; there are tradeoffs. You’ll need to weigh the pros and cons concerning where you are in your business. But you don’t have to do that alone. In fact, it’s not a good idea to go it alone. Talk with a broker about your goals for equipment in relation to your operational or growth plans. They’ll match you with options that fit instead of a generic one-size-fits-all financial product. Your business is unique, and your financing should fit like a glove.