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New
Equipment: Should You Buy or Lease?
by Nancy Nichols
Once you
decide what equipment to buy, how will you pay for it? As
a small-business owner, you have several options. You can
pay cash, borrow the money from a bank, or lease the equipment
through a vendor or a third party. For most small companies,
leasing may make the most sense. Which route you choose, however,
all depends on your company's circumstances.
Those
that can afford to pay cash for a large purchase generally
pay the least for their equipment. However, saving money on
equipment may not be your highest priority. Excess cash may
generate a better return invested in marketing or sales rather
than in such hard assets as computers. Then too, if the equipment
you buy is likely to become obsolete fairly quickly, you probably
don't want to own it. If paying cash still looks good, ask
yourself if you have the tolerance for the annoyances that
come with ownership: If the computer breaks down or the copier
permanently jams, you must live with it no matter what.
Paying
cash can be attractive. It's the least expensive option because
you avoid the steep financing charges that come with borrowing
or leasing. It can be the best option for an owner who can
predict his or her future equipment needs, is confident that
the machines will not quickly become obsolete, and doesn't
have a better place to invest the capital.
For the
majority of small companies that can't or don't want to pay
cash, borrowing or leasing are the only viable choices. Borrowing
tends to be less expensive than leasing, although much depends
on the creditworthiness of your company and the kind of relationship
you have with your banker. Generally, interest rates on loans
will be lower than on leases.
Leases
also tend to be expensive. Unlike vehicles, residual value
is not on your side. If you lease a $18,000 car for your business,
for example, it can be sold after three years for perhaps
$9,500, which means that during the lease period you pay the
depreciation plus interest. But office equipment such as copiers
and personal computers has little value after five years,
so you'll have to pay close to the full cost of the machines
plus interest through the lease period.
If borrowing
is starting to look attractive, consider whether you can live
with its disadvantages. You will have to use a portion of
your credit line that might be put to better use elsewhere.
You'll own the equipment, too, which exposes you to a double
risk of obsolescence. More advanced equipment reaches the
market every few years, offering attractive new applications.
And if your company is growing, the equipment might become
a drag on your operations a few years hence.
To sidestep
these problems, many companies choose to lease instead. Most
lessors will provide 100% financing. And unlike bankers, many
lessors offer flexible payment schedules. It is often possible
to negotiate a payment schedule that adjusts to your seasonal
cash flow. Leases may also include an option to renew at a
specified rate or to purchase the equipment at a specified
price. You can also lease used equipment, substantially reducing
your costs.
Perhaps
the most important advantage of leasing is that it offers
protection from the rapid obsolescence of office equipment.
Companies can trade up to more powerful equipment as their
needs evolve. That flexibility is valuable for companies that
cannot predict their technology needs even a few years in
advance. Better to have a flexible, expensive lease than a
sizable investment in outdated equipment. In fact, about 60%
of all computer leases nationwide are renegotiated midterm.
Leases
have some disadvantages, too. A lease is a binding contract
that carries penalties if you decide to cancel it midterm
and return the equipment. There are two types of leases: finance
leases and operating leases. Most leases for small office
equipment are operating leases, in which ownership of the
machines usually reverts to the vendor at the end of the lease
term. For tax purposes, operating-lease payments are treated
as an operating expense, not a capital investment, and are
deducted immediately from operating revenues. In addition,
the lease does not appear as a liability on your balance sheet
the way a loan to purchase the same equipment would. That
would make it easier for you to borrow money in the future.
Finance
leases, also known as full-payout or closed-end leases, require
a company to purchase the equipment at the end of the lease
period at a percentage of the original price or for a nominal
amount. Since a finance lease is, in effect, a loan in which
ownership eventually passes to the lessee, the equipment is
treated for tax purposes as a depreciable asset, and the lease
will appear on your balance sheet as a liability.
So which
option is best for you? The key factors are your cash position,
the availability and cost of borrowing, and potential obsolescence
of equipment. Companies with strong cash positions and good
banking relationships are often best served by buying or borrowing
for equipment that will have a long life. If obsolescence
is a concern, a short-term operating lease will bring flexibility.
But if cash flow is a problem and the equipment will remain
viable for years, a long-term finance lease with a final residual
payment will give you the lowest payments plus a purchase
option. (For a summary, see "Which Financing Option Is Best
for You? below).
Which
Financing Option Is Best for You?
Cash
…
Generally
the least expensive option
Enables
you to depreciate the equipment
But
it ...
Is in short supply at most small companies
Might
be better spent elsewhere
Exposes you to the risk of obsolescence
Borrowing
…
Generally
is less expensive than leasing
Enables
you to depreciate the equipment
But
it ...
Uses
a credit line that could be used elsewhere
Exposes
you to the risk of obsolescence
Represents
a liability on your balance sheet
Leasing
...
Protects
you best from obsolescence
May
not be a liability on your balance sheet
Enables
you to get 100% financing
But
it ...
Is the most expensive way to buy equipment
Carries
penalties for cancellation midterm
Nancy
Nichols is a Philadelphia-based business writer.
Copyright
© 2000 Inc. Business Resources
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