Six Myths of Equipment Leasing

Edition: June 2002 - Vol 10 Number 06
Article#: 1261
Author: Greg Einhorn

Myth No. 1: Your customers don't lease.


Some people think that leasing has to do with the financial condition of a business. “This doctor's practice is doing well, so he doesn't have to lease.” That's not true. Leasing is a business decision that makes financial sense for all kinds of companies from Fortune 500 companies to lawyers, accountants and medical practitioners.


Myth No. 2: Leasing is too expensive.


Some of the world's most savvy financial institutions lease equipment for their businesses, including American Express, Paine Webber and Merrill Lynch. No one would call into question their ability to negotiate a good deal.


Myth No. 3: Leasing is for customers who can't afford to pay cash.


Not true. Companies lease because they have found better uses for their money than tying it up in equipment. They have learned to leverage their dollar. With a monthly leasing payment, they have use of a piece of equipment without a large outlay of cash. For any business, operating capital is more valuable than cash tied up in equipment.


Myth No. 4: You can only lease hard capital goods.


The fact is, businesses can lease anything from software to services. Most leasing companies, including ours, provide funds for leasehold improvements, supplies and working capital – most any practice's needs.


Myth No. 5: You jeopardize the sale if you bring up leasing to your customer.


Leasing carries with it some negative connotations, stemming perhaps from a general attitude about borrowing money or over-leveraging your business to purchase equipment. Also, for some businesses leasing a piece of equipment means that they don't own it; and people like to own things (although most of our leases result in the customer buying the equipment). People also like to have their things paid off. Nobody likes debt. For all of these reasons, sales reps are reluctant to bring up the topic of leasing. But it's their job as salespeople – especially in this age of growth and quickly changing technology – to present their customers with all their financing options, including leasing.


Myth No. 6: If you lease something, you're locked in for the term of the lease.


Virtually all leasing companies, ourselves included, offer some kind of prepayment or early “out” clause or trade-up and restructuring opportunities. There's almost always a “back door” to get out.





Leasing is a valuable sales tool – too valuable for reps not to bring up to their customers.


What are the Differences Between a Lease and a Loan? Loan Lease        










































































A loan requires the end user to invest a down payment in the equipment. The loan finances the remaining amount.A lease requires no down payment and finances only the value of the equipment expected to be depleted during the lease term. The lessee usually has an option to buy the equipment for its remaining value at the end of the lease.
A loan usually requires the borrower to pledge other assets for collateral.The leased equipment itself is usually all that is needed to secure a lease transaction.
A loan usually requires two expenditures during the first payment period; a down payment at the beginning and a loan payment at the end. A lease requires only a lease payment at the beginning of the first payment period, which is usually much lower than the down payment.
The end user bears all the risk of equipment devaluation because of new technology.The end user transfers all risk of obsolescence to the lessors, as there is no obligation to own equipment at the end of the lease.
End users may claim a tax deduction for a portion of the loan payment as interest and for depreciation, which is tied to IRS depreciation schedules.When leases are structured as true leases, the end user may claim the entire lease payment as a tax deduction. The equipment write-off is tied to the lease term, which can be shorter than IRS depreciation schedules, resulting in larger tax deductions each year. The deduction is also the same every year, which simplifies budgeting (equipment financed with a conditional sale lease is treated the same as owned equipment.)
Financial Accounting Standards require owned equipment to appear as an asset with a corresponding liability on the balance sheet.Leased assets are expensed when the lease is an operating lease. Such assets do not appear on the balance sheet, which can improve financial ratios.
A larger portion of the financial obligation is paid in today's more expensive dollars.More of the cash flow, especially the option to purchase the equipment, occurs later in the lease term when inflation makes dollars cheaper.





Benefits of Leasing


Tax treatment. The IRS does not consider an operating lease to be a purchase, but rather a tax-deductible overhead expense. Lease payments can be deducted from corporate income.


Balance sheet management. Because an operating lease is not considered a long-term debt or liability, it does not appear as debt on the company's financial statement, thus making the company more attractive to traditional lenders.


100 percent financing. With leasing, there is little money down; perhaps only the first and last month's payment are due at the time of the lease. Since a lease does not require a down payment, it is equivalent to 100 percent financing. That means the customer has more money to invest in revenue-generating activities.


Immediate write-off of the dollars spent. Leasing payments are treated as expenses on a company's balance sheet; therefore, equipment does not have to be depreciated over five to seven years.


Flexibility. As a business grows and its needs change, it can add or upgrade at any point during the lease term through add-on or master leases. Customers also have the option to include installation, maintenance and other services, if needed.


Customized solutions. Companies can customize a program to address their needs and requirements – cash flow, budget, transaction structure, cyclical fluctuations, etc. Some leases allow the lessee, for example, to miss one or more payments without a penalty, an important feature for seasonal businesses.


Asset management. A lease provides the use of equipment for specific periods of time at fixed payments. The lessor assumes and manages the risk of equipment ownership. At the end of the lease, the lessor is responsible for the disposition of the asset.


Upgraded technology. If the nature of the customer's industry demands that it have the latest technology, a short-term operating lease can help. The risk of getting caught with obsolete equipment is lower because the customer can upgrade or add equipment to meet changing needs.


Speed. Many leasing companies can approve a customer's application within one or two days.


Improved cash forecasting. By leasing equipment, the customer knows the amount and number of lease payments over the life of the leasing period.


Flexible end of term options. There are several options for disposing of equipment after the lease term ends, including returning the equipment, renewing the lease or purchasing the equipment.


Tax benefits. Lessors often pass the tax benefits of ownership on to the lessee in the form of lower monthly payments.


Improved earnings. Operating lease accounting provides a lower cost than a capital lease in the early years of a lease


Types of Leases


There are many types of leases to choose from. The type of lease your customers select should match their equipment needs, business goals and cash flow requirements. For example, some lessees need one piece of equipment that requires a single contract. Others may continually acquire equipment and exercise a master lease that allows them to acquire many items within a single lease and avoid executing a new contract with every acquisition. The most common types of leases are operating leases and finance leases.


Operating Lease


An operating lease is for companies that continually update or replace equipment and want to use equipment without ownership, but also want to return equipment at lease-end and avoid technological obsolescence. Such a lease usually results in the lowest payment of any financing alternative and is an excellent strategy for bypassing capital budgeting restraints. It typically qualifies for off-balance sheet treatment and can result in improved Return On Asset (ROA) due to a lower asset base. It can also result in higher reported earnings in the early years of the lease.


Finance Lease


A finance lease is a full-payout, noncancellable agreement, in which the lessee is responsible for maintenance, taxes and insurance. It is most attractive in cases where the lessee wants the tax benefits of ownership or expects the equipment's residual value to be high. These leases are structured as equipment financing agreements with residuals up to 10 percent. The lessee purchases the equipment upon lease termination at a pre-agreed amount. The term of a finance lease tends to be longer, nearly covering the useful life of the equipment.





ABOUTH THE AUTHOR:


Greg Einhorn
is director of sales for Group Financial Services (www.finservices.com), which acts as the financial services division of National Distribution and Contracting (NDC), Nashville, TN.