Six Myths of Equipment Leasing
Edition: June 2002 - Vol 10 Number 06
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.
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.
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.