By Keith Trumbull
There are benefits to either leasing or owning a piece of equipment, depending upon your objectives, and it’s imperative for decision makers to perform a cost analysis to help identify which method is best for your needs.
Last month, we shared the seven factors to analyze for a better understanding of your organization’s asset costs. This month, we’re diving into the differences between leasing and owning assets. There are advantages and disadvantages of each depending on your organization’s specific needs. Prior to making the decision to lease or own an asset, it is important to accurately compare costs.
To better understand the way asset financing works, it’s essential to first understand the financial terminology. A lease is a long-term agreement in which one party, the lessee, agrees to use the property of another, the lessor, over a specified period of time in exchange for periodic payments to the lessor.
There are many reasons to choose to lease material handling equipment. When leasing, organizations can leverage the asset expertise of the leasing company. This expertise can be valuable for organizations of all sizes. Leasing allows you to conserve current cash, freeing up funds for other investments in your business. The payments are spread out over the period of time that you use the asset, usually without a down payment. Leasing an asset can protect a company against owning equipment that may become obsolete. The lease can also be structured to meet other business objectives of the company through off-balance-sheet financing. Operating leases allows the asset to stay on the lessor’s balance sheet, while the lessee reports only the required rental expense for use of the asset. Additionally, there generally are no restrictions on a company’s financial operations, commonly referred to as loan covenants.
Alternatively, reasons to own a piece of material handling equipment are flexibility in usage and maximum control over the asset. Additionally, when your organization has excess capital or existing banking relationships with excess capacity, it might be best to purchase equipment. The company will also retain the resale value of the asset and can utilize the depreciation to offset income.
It’s imperative for decision makers to perform a cost analysis to help identify when to lease versus when to purchase a piece of equipment. This comparison is generally done through a discounted cash flow analysis, which examines factors including the timing of payments, interest rates, tax benefits and other financial considerations in each arrangement. To compare each option, discount the cash outlays for each year of the arrangement to a present value. Then add each year’s present value to obtain the sum of the present values of each option. The lowest total present value is the best financial option.
While the lowest present value is the best mathematical choice, other critically important considerations in your choice are:
• Availability and alternative uses of capital
• Income tax treatment and considerations
• Sales and rental tax treatment in the jurisdiction where the asset is held
• Internal capital budgeting versus operating cost budget authority and approvals
• Financial statement implications
• Final structure and terms that meet the financial needs of your organization and the operating needs of the end users of the assets
Regardless of whether you decide to lease or purchase, it may be helpful to speak with a financing expert. There are benefits to either leasing or owning a piece of equipment, depending upon your objectives. If you have any questions, feel free to contact me.