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Should You Lease or Should You Buy?

August 16, 2009

By Mike Clough,  2009

A very popular question among small business owners is whether it is better to lease or purchase. As with most things, that depends on what it is you are thinking of acquiring and your specific financial and tax situation.

Leasing offers several advantages, especially for cash-strapped small businesses planning to acquire technology which tends to be quickly outdated.   Leasing offers the ability to free-up working capital and have cash to grow your business.  For small business, a main issue in the debate over leasing or purchasing is having enough capital to run and grow operations. Meeting tight payroll deadlines or buying inventory are only two of the very real strains on cash flow.  When it comes to putting down a large sum of cash or going to the bank for credit to buy or upgrade equipment, an equipment leasing option can be a better alternative for small businesses. Having cash reserves invested in equipment makes the company asset rich and cash poor. Cash poor companies cannot respond to changing market conditions or take advantage of new opportunities.

So, I teamed up with Robert Long MA, CPA, PA) of Coral Springs, Florida to secure more specific answers.  He has been serving small businesses for decades. As the internet and email has made our world more virtual, he is now serving small business owners in many states across the nation. So here are his thoughts on the subject.

Leasing Has Advantages
Minimal upfront costs. With a typical lease, you have little upfront costs, unlike an outright purchase.  Instead, you pay a set monthly fee for the life of the lease.  These predictable monthly expenses help with cash flow management.  The flip side of that is that you end up paying out more over the asset’s life than you would have paid if you purchased the asset.

Banks often require business plans and several years of banking and credit to purchase any given asset.  An equipment leasing company will not need a business plan and may only require a few months of credit history. On the negative side, there may be additional fees for advance payments, insurance requirements or prepayment of penalties for ending the lease early.  

Two Kinds of Leases 

Of the two kinds of leases – capital leases and operating leases – each is used for different purposes and results in differing treatment on the accounting books of a business.  Capital leases give the lessee (person leasing) the benefits and drawbacks of ownership, so they are considered as assets, but they may be depreciated.  For example, the depreciation you can deduct on a car lease depends on the size and type of car. The company may be eligible for special depreciation rules such as increased Section 179 limits, which may also be available with purchasing, so check with your tax adviser before you lease.

With an operating lease:

The lessee uses the property but does not take on the benefits or drawbacks of ownership, which are retained by the lessor.

  • The rental cost of an operating lease is considered an operating expense

Equipment bought on a loan is depreciated over several years but the monthly lease expense is deducted in the current year.   Interest on the loan can be expensed with asset purchasing.

Why Not Lease?

Purchasing May be Right

Given all the potential benefits of the equipment leasing advantage, it may make business sense for small business owners.  But here are two downsides to equipment leasing. One, the cost of the equipment is much higher than an outright purchase.  Two, at the end of the lease contract the company does not own the equipment, the lessor does.  So what is the best option?

Buying is easier up front, that is if you have the cash up front.  Buying is also ultimately less expensive due to the financing charges with leasing.   To lease, you or your business must be prequalified, and there can be lots of details in the lease agreement to consider.  

One should have a good idea of the end goal of where he or she expects the company to be in the future.  That is, if you are planning on selling the company in a few years, the higher net worth from equipment leasing can be more attractive to buyers. 

On the other hand, having a strong balance sheet with high quality assets in place may be desirable.  These are all areas which need to be considered in your business plan.  

With owning, the equipment is depreciated and sometimes bonus depreciation can be utilized and any interest on financing can be expensed.  This could result in significant tax savings.  An effective way to make the comparison is to do a mathematical analysis of your net cash flows that would result from leasing and from purchasing.  A cash flow analysis provides an estimate of how much cash you would need to set aside today to cover the after-tax costs of each acquisition alternative.  And of course, the asset would have to be of significant worth to justify the time, money and expertise on such an analysis.  In the end, it’s still probably best to contact your accountant to help decide which is best for you, buying or leasing. 

Hopefully, this will give you some things to consider when you evaluate leasing vesus buying.

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