A number of my small business customers often ask me whether they should lease or buy capital expenditures. Often companies with a strong cash position tend to favor an outright purchase of the equipment or machinery. In other instances, small businesses with cash flow concerns, tend to lean towards leasing as a means to retain more cash on hand. However, there is one option that most companies should choose regardless of their cash position. One that might be considered the best option in every situation. Interested in knowing which one that is?
Equipment Capital Expenditures Depreciate Over Time
Unfortunately, it’s that last assumption I mentioned that typically forces small businesses to realize that capital investments should be leased. Equipment leasing is a much more viable option considering the depreciating value of these assets. When my customers are faced with the decision to lease or buy, they base that decision on the following.
1. Uneven Cash Flow: Most small businesses with cash flow problems have little choice but to lease. They manage tight cash reserves and must mitigate the amount of cash available for expenditures. They simply lack the capital position to invest in a total outright purchase of the equipment.
2. Strong Cash Flow Position: Companies with a strong cash position believe this affords them an opportunity to avoid financing equipment. Instead, they pay cash for the purchase and are able to not only reduce their financing charges, but also to secure discounts and incentives for prompt payment. While having a strong cash position is a plus, leasing is still a more viable option long-term.
While some companies may have the funds available to purchase machinery outright, they must be vigilant with respect to the highs and lows of business cycles. Today’s strong cash position is tomorrow’s cash flow problem. In addition, there are other benefits to leasing.
Small businesses that lease are able to avoid the pitfalls of machine and equipment obsolescence, are able to benefit from capital tax deductions, avoid high consumable and ancillary part costs, as well as properly navigate the threat of purchasing the proverbial “lemon”. In fact, the costs of these consumables and spare parts are an important part of the total overall cost of ownership. These three benefits are elaborated on below.
1. Avoiding the Pitfalls of Machine & Equipment Obsolescence
Business today is all about speed and the “newness” of things. It seems like every time something new comes out, something newer comes out the day after. Of course, this ensures consumers keep buying and keep upgrading purchases. However, in business to business capital investment, the reality is that allocating large amounts of capital to equipment and machinery can backfire, especially if that purchase becomes antiquated.
2. Stronger Cash Flow Position & Tax Deductions
Small businesses prefer leasing because of its ability to improve cash flow and allow for corporate tax deductions on depreciating assets. Companies are able to establish monthly payments that are fixed relative to the leasing options they pursue. In fact, leasing capital expenditures like equipment has become so popular that according to the ELFA (Equipment Leasing & Finance Association) approximately 8 of 10 US businesses choose leasing over buying.
Depreciating a fixed asset allows your company to reduce its tax burden by lowering your revenue - on paper. To read more about depreciating fixed assets, please read: Fixed Asset Management: Straight Line Depreciation on Capital Expenditures
3. Avoiding High Ancillary Part Costs & The “Lemon”
Cost of ownership is an extremely important factor when looking at purchasing equipment and machinery. The cost of consumables, ancillary parts and service are all a part of the cost of ownership. Purchasing machinery outright, only to find out that the machinery requires more servicing and upgrades than initially thought, is a recipe for disaster. In addition, finding out that equipment your company just purchased is a lemon, is certainly no fun either.
One of the immediate benefits of leasing is that most any piece of machinery and equipment is a candidate. Whether it’s a company’s fax machines, its cars & trucks, computers, cell-phones etc, all can fall under some kind of leasing arrangement. However, for large capital purchases, companies must do more than merely choose between leasing or buying. Ultimately, they must review all aspect of the costs of the purchase.
To elaborate on the cost of ownership, I’ve included a link to two articles that will help explain the process behind a “go/no-go” decision on a large capital expenditure.
What's Involved in Making a Decision on a Capital Expenditure?
Best Business Practices: Simplifying Return on Investment (ROI)
To learn about the impacts of the cost of capital on your company's bottom line, please go to: Cost of Capital, Cost of Borrowing Money and Your Bottom Line
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