Chapter 18: Leases

Leasing Versus Buying Equipment: Which is the Best Choice?

The short answer to this question is "it depends." The question of leasing versus buying has always been a sticking point for business management decisions because equipment is often a high-priced item and can require the firm to pay out a lot of cash. The following are some of the advantages and disadvantages of leasing equipment.

Leasing Advantages

• Low up-front costs and predictable payments over the lease term. Leasing allows for a minimal initial cash payment, regular predicable payments, and a predictable interest rate over the life of the lease, making cash flow management easier. This is a significant consideration for new companies with a lot of competing cash flow needs, or existing companies expanding their business market share or product lines.
• Protects against obsolescence. Non-current assets such as equipment are part of the asset base from which a company generates its revenue and profits. For this reason, these assets should be monitored and kept as efficient and productive as possible. That said, many businesses treat owned equipment as a permanent fixture and often do not plan for major repairs or eventual replacement. As a result, when that time comes, there may not be enough cash set aside to address these repair or replace requirements adequately. Old equipment often gets stretched to the limit and beyond, increasing production downtime and negatively impacting revenue and profits. Often the additional costs to operate and repair old and outdated equipment outweighs any interest costs incurred for leasing new equipment that would maximize efficient production costs, generating more revenue and profits.
• New technology improves productivity. The lower entry cash requirements and the option to dispose of the equipment at the end of the lease term enable businesses to employ the most advanced technology within their industry sector. This gives them an edge over their competitors in terms of better productivity, more competitive pricing, and potentially employing fewer people. Leasing also enables businesses increased flexibility so they can change equipment quickly in response to changing environments and customer needs.
• Tax benefits. Operating lease payments are recorded as operating expenses, so they are tax deductible, and the lease is reported as a leased asset obligation on the balance sheet (referred to as off-balance sheet financing). This means that operating leases will usually not negatively impact the company's liquidity and solvency ratios or any restrictive covenants from other creditors.

Leasing Disadvantages

• Higher ownership costs. Leased equipment is generally new, which tends to depreciate the most in the early years.
• No accumulated equity. Depending on the type of lease, businesses will never have title or ownership, so there is no equity to accumulate.
• Lease payments always exist. If a business is seasonal, there may be slow cycles throughout the year where the equipment is idle. Under a lease agreement, cash payments continue, which could put a strain on a business going through a slow cycle or downturn. Also, with leasing agreements, negotiations are necessary, and businesses are subsequently tied to the specific lease term.
• Scheduled maintenance and repair costs. Many leasing agreements include a structured repair and maintenance schedule that must be followed by the lessee. With equipment ownership, the business can make its own decisions about when maintenance is required.

(Source: Landscape Managing Network, 2010)