Every kind of business will eventually acquire new equipment and capital assets to continue its operations — manufacturers periodically upgrade their factory machines, service providers require the latest gear to serve their clients, retailers update store and warehouse fixtures, and executive and administrative offices retire outdated furniture, cubicles and computers. Although these investments can bring benefits to your enterprise from an efficiency and competitive perspective, a new equipment purchase typically presents a confusing array of financing options along with several potential pitfalls.
The first choice you'll need to make is whether to purchase the equipment outright (using cash on hand or your bank line of credit) or lease the equipment from a bank, leasing company, or equipment manufacturer or distributor.
Generally speaking, equipment leasing requires less cash up front (100 percent financing is often available) and will be permitted under the loan agreements with your existing senior lender. In addition, leasing almost always results in lower monthly payments than an outright purchase because:
- Leasing companies usually offer longer lease terms than those of a typical bank equipment loan.
- With a lease you’re paying only for the right to use the equipment during the lease term (a shorter period than the equipment’s total useful life).
Leasing is also more flexible than a purchase since, at the end of the lease term, you have three options:
Analyze Your Budget
Although your annual budgets presumably include an allowance for upgrading capital assets, take another look at those numbers keeping your current monthly cash flow in mind. Factors to consider include:
- The extent to which your cash flow is seasonal (lenders and leasing companies can often structure payments accordingly).
- Whether the equipment purchase will be a one-off or a series of acquisitions over time.
- The additional revenue or profit (through reduced expenses) that will be generated by the new equipment. For example, the new equipment may enable you to service larger clients or produce product more quickly, thereby creating more revenue. Or the new equipment may reduce maintenance costs (compared to the old equipment being replaced) or increase productivity, thus permitting you to shed employees.
Choose Your Lessor
If your financial analysis points to a lease, you can lease equipment from a bank, a leasing company that specializes in equipment financing or an equipment manufacturer/distributor (also known as a "captive” lessor).
Banks typically have the most expensive financing, but it may be easier and faster to use your existing senior lenders since they already know you and your business. Leasing companies usually offer the most flexible terms. If your business will continue to need a large volume of new equipment over time, banks and leasing companies offer asset management consulting services to help you create a long-term equipment acquisition strategy.
Captive lessors often have the least expensive financing but give you fewer choices since they will only finance their own brand of equipment.
Understand the Tax Treatment
You’ll want to consult your accountant about your company’s particular tax situation, but as a general rule, the federal tax code often makes leasing more attractive than outright purchases. When you acquire equipment — either by purchasing or leasing —you are required to amortize, or spread out, the cost of the equipment over its useful life, taking depreciation deductions each year.
Section 179 of the tax code may permit you to deduct the entire purchase price in the year the equipment was acquired, subject to various dollar limits and conditions. When applied to an equipment lease, the permitted 179 deduction can often exceed the total amount of the lease payments, making it very attractive from a cash flow/profit perspective. Of course, if you take the Section 179 deduction in Year 1 for all the lease payments, you can’t also deduct those lease payments as an annual business expense during the term of the lease.
Spending some time looking at your financial options and comparing the effect of a lease versus a purchase will pay dividends in the long run, helping you upgrade or add equipment in a way that works best for your bottom line.