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Financing Equipment vs. Leasing Equipment
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Equipment is defined as assets, other than property or buildings, that are used in the operation of a business. Depending on what industry your business operates in, this can include everything from bulldozers to excavators. For those who require heavy machinery for their business, the cost of purchasing equipment can be prohibitive. Financing or leasing the equipment is a solution that can reduce the impact of a large purchase on cash flows. Both options have their advantages and disadvantages; let’s take a deeper look below.
An equipment lease is a form of financing that allows you to essentially rent the equipment. The lender purchases the equipment and you pay them in installments for the right to operate that piece of equipment, but you will not own the equipment at the end of your lease term. However, most lenders will include a clause that will allow you to purchase the equipment based on its residual value at the end of the lease term.
In regards to equipment leasing, there are two different types:
- Operating Lease. An operating lease is similar to a rental agreement as the equipment remains the property of the lessor. Lease payments are considered operating expenses and are included in a company’s profit and loss statement.
- Capital Lease. A capital lease is sometimes referred to as a finance lease and is similar to a loan. Ownership of the equipment may be transferred to the lessee at the end of the lease term, for example, through a buyout clause. Lease payments under a capital lease are listed on the company’s balance sheet rather than the profit and loss statement and the business can claim items like depreciation and interest.
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Advantages and Disadvantages of Leasing
As mentioned, leases have advantages and disadvantages to consider. It’s important to understand the pros and cons before you make a decision to ensure you’re making the right choice.
- Lower upfront costs. Typically, there are no down payments required for an equipment lease. This reduces your initial cash outlay when compared to loan or purchase options.
- Lower liability. In most cases, lenders will not require you to provide any collateral or personal guarantee which reduces your liability as a business owner.
- Greater flexibility (at the end of the lease). At the end of your lease, you may have options to either renew or end the contract. Additionally, some lenders may offer the option for you to purchase the equipment at the residual value at the end of the term. The choice between renewing, ending, or buying at the end of the lease is beneficial.
- Less hassle. General equipment repairs will typically be covered by the lessor, which means that you won’t have to deal with any third parties for upkeep. Furthermore, you can simply trade in your truck for a newer model at the end of the lease term rather than have to worry about long term maintenance costs.
- No ownership. With a lease, your regular payments do not go toward the eventual ownership of the equipment. An equipment lease is essentially a rental agreement.
- Fewer opportunities for tax claims. Lease payments are operating expenses and you will not take possession of the equipment as an asset which reduces the potential for your business to receive a break when you file your business’ tax return.
- Higher cost. Leases tend to have higher interest rates than loan options which means that you could end up paying more over the course of the lease than if you were to simply buy the equipment.
- Lower Flexibility (during lease term). The lessor may place restrictions on how the equipment can be used or modified over the course of the lease term. Additionally, you are unlikely to have the flexibility to end the lease early or to sell the equipment.
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An equipment loan is an amount of money borrowed for the purpose of purchasing equipment and is repaid with regularly scheduled payments. At the end of the financing term, you will own the equipment outright. While most equipment loans are unsecured, the equipment itself acts as the collateral to the loan and the lender may repossess the equipment if you fail to make your payments.
Pros and Cons of Equipment Financing
Equipment loans have their own advantages and disadvantages when compared to leasing options. Let’s take a look at some key points:
- Ownership of an asset. When financing your equipment, your payments will go toward the ownership of the asset.
- Easier to qualify. The process for approval for an equipment loan is typically easier than other business loans because the equipment acts as collateral. In addition, financing options may even be available to businesses with low credit scores or little credit history.
- Building credit for your business. Paying off your equipment loan will help your business build credit and make it easier and cheaper to borrow in the future.
- More opportunities for tax claims. Equipment that is financed is considered an asset in terms of accounting. Business owners can claim credits for things such as interest and depreciation.
- Higher upfront costs. Most lenders will require a downpayment on an equipment loan which will increase your upfront costs. The amount required for a down payment will depend on your business’ qualifications, but typically it will range from 10% to 25%.
- Maintenance and repair costs. When financing your equipment purchase with a loan, you will likely have to pay for maintenance and repairs. Even if you are provided with a warranty on the equipment, you will be responsible for the long term costs of upkeep once the warranty expires.
- Outdated equipment. If the term of financing for the equipment loan is a long period of time, the asset may become outdated before it is paid off thereby causing negative equity. While you will eventually own the equipment, there could potentially be newer models on the market that are cheaper and more efficient.
Should You Lease or Buy?
Whether you should lease or finance the purchase of equipment depends on the current status of your business. Typically, leasing is preferred for businesses that only need the equipment for a limited period of time or if the company does not have the cash available to make a down payment. Equipment loans are recommended for companies that are looking to keep the asset for a long period of time. Also, if your business’ financial position can support a sizable down payment, you may be offered preferable terms such as lower interest rates and longer terms.
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