- THE MAGAZINE
In 2003 and 2004 we looked at some of the factors to consider when deciding which financial path to follow, leasing or owning. The same fundamentals explored then still apply today.
There comes a time in the life of every business when, in order to grow and take advantage of every opportunity, it is necessary to extend beyond everyday assets and cash flow. Perhaps it's time to acquire a new truck and cleaning machine. Maybe you need more space or some specialty drying equipment. In any case, when the opportunity arises, you are often faced with the decision of whether it is better to purchase through financing or to lease. There are features of both options that, depending upon your circumstances, will make a difference in your decision.
For many years, leasing was common because of the very low (sometimes zero) amount of money required upfront, or "money down," and the low interest factors resulting in low monthly payments. Leases often have very attractive end-of-lease buyout options as well. Occasionally, the equipment supplier would have special arrangements with the leasing company to get approvals for small businesses that would otherwise have difficulty qualifying with a bank or other lending institution.
However, new business start-ups are rarely accepted without some kind of personal guarantee in place. In some cases there are very stiff penalties should you find yourself in a position to want to end the lease early, especially in the case of vehicles.
Standard financing toward ownership is another alternative when you need additional equipment or facilities. The obvious advantages of ownership include building equity and having more control. Financing generally requires a larger down payment than leasing and, when interest rates are up, financing may require a larger monthly payment than leasing. Low interest rates make the financing option very attractive at present.
Another factor that may enter into your decision to finance or lease is taxes. When you own, or finance, you have the opportunity to depreciate the value of the equipment on your tax returns over a few years, while leased equipment cannot be depreciated.
However, lease payments (including interest) can generally be expensed off of your income statement, thereby reducing your taxable income. To determine which option represents the best tax opportunity for your business you should consult your professional accountant.
Whatever you decide, it is important to make sure all your company finances are in order before applying. Take the time to prepare a business plan that shows how the equipment or property being acquired will contribute to the overall productivity and profitability of the business. In a nutshell, be able to demonstrate to the financing party or leasing company how you plan to generate the money needed to make the payments. For example, show business projections including the production from the new truck mount you are purchasing that will more than cover the payments. Include some market analyses to show that the business is indeed out there, and a marketing plan outlining how you plan to get your share of it. Things that are especially helpful here include new contracts that may account for your projected growth and historical trends pointing upward in the last year or two.
If you are a relatively new business (less than five years old) it will probably be difficult to get a finance or leasing company to approve your request without some personal guarantees from the principals of the company. Sometimes a leasing company is more willing to take on a newer business at a slightly higher factor, while banks or finance companies are not as likely to do so. This is because there is a very high rate of failure for new service companies in the first five years of operation.
Generally, once a business is able to show five years of successful operation it is considered stable enough that financing or leasing can be approved without personal guarantees. The track record established over those five years includes a history of paying bills, steady growth and good business practices.
Every growing business has a certain amount of debt it incurs, and a need to lease or finance from time to time. The smart businessperson looks at every opportunity carefully and weighs every side of the equation before making a move. Remember to consider the required down payment, the interest factor, the payment, the tax issues, the length of the time frame involved for completion and the income potential represented by the new equipment or property being purchased or leased. Your best friend here is probably your accountant. Take the time to do your homework and make a wise, informed decision before you sign on the dotted line.