Equipment Leasing Versus Purchasing
Here's a look at the financial, tax, and business planning aspects of acquiring major machinery through a lease agreement, compared to purchasing outright. December 27, 2008
Question
As a one man shop, I have always purchased all my equipment outright. I'm looking at purchasing several large machines in the near future to increase production and to get more work through the shop. What is the upside/downside of leasing vs. buying?
Forum Responses
(Business and Management Forum)
From contributor T:
Unless you don't have anything else to use your money for, I would consider leasing as a pretty good option. First, it allows you to use your cash for other things, like COGS, including materials and labor. Second, leasing allows you to buy things you can't afford to pay cash for at the time. Third, leasing allows you to take productivity gains immediately, rather than use the payback to pay off the upfront cash you paid for equipment over a couple of years.
You might also wish to consider software when leasing. It is normally easy to bundle a software solution into the lease in order to keep the payment reasonable.
Most leases offer a one dollar payout at the end of the lease. You will pay more for the equipment, but then again, you are anyway when you consider lost investment opportunites on the cash you laid out for upfront deals.
Finally, you may want to talk with your accountant about the possibility of getting tax breaks and depreciating the equipment while leasing. There may be some possibilities worth considering.
From contributor S:
We were going to lease a CNC router one time and the salesman told us the interest rates, etc. When it came time to sign, the rates had jumped 7 points. He had told us it would be 7% and it was actually over 14% when you add it all up. When we confronted him about the increase, he said he told us it would be around 7%. We canceled the deal on the spot since we no longer trusted him. Make sure you read everything very carefully.
From contributor J:
I leased a brand new Brandt edge bander in May of 03 - bought a real good commercial unit - and made my final payment yesterday! That edgebander paid for itself many times over and still looks brand new. Please consult your CPA for the tax benifits. I believe the $1.00 buyout can be realized all at once where the write-off is concerned.
From contributor W:
Beware of the 179 deduction. This is advanced depreciation and since the leasing company owns the equipment, you can't take advantage of this at all. You have paid full price for a piece of equipment that the leasing company has taken depreciation on! You have lost money big time. If you can buy, do so.
From contributor D:
To clarify contributor W's statement, he would only be correct if the equipment were purchased in a lease that were structured like a vehicle lease where you were not purchasing the full value of the equipment, which is very, very rare in the machinery business. A capital lease, which means that you are financing the full value of the equipment with a $1 buyout at the end of the term, is fully depreciable the day that the equipment hits your floor.
From contributor W:
Thanks. Looks like I may have gotten the wrong information this year. I did depreciate my equipment, but my software wouldn't let me this year. Turbotax may have an issue there.
From contributor B:
I am not recommending one thing over another, but there are a couple of alternatives to leasing. I bought an Altendorf slider direct through my machinery distributor by paying 1/3 up front, and dividing the balance over 3 months. No leasing, bank loan, no interest charges, but that was only $20k. There are also machinery lines of credit through the bank. I believe you need to be aware of the write-off of payments and the ability to depreciate the equipment. I am old school, and leases and loans are a monkey on my back, although I have done both. Right now I own everything, but I want another CNC machine and I'm trying to figure a way to make it happen.
From contributor A:
I'm a one man shop. With the way the economy is right now, I'd think long and hard about anything other than cash. I could close up shop for 6 months and not be any worse for it. But if I had a lease payment, I would not have that option. Do it like grandma. Save up and pay cash.
But if you have that much work to do, and have signed contracts to x number of widgets, and you could go to your local bank and show them contracts for the widgets, then I might take out a loan to buy machines to make the widgets. But only if the ROI was at least break even within the term of the initial contracts I had signed. I would forgo any profit and consider the machine purchase my profit on that job.
But on pure speculation of future jobs, no lease, no loan. Save and pay cash.
From the original questioner:
Thanks for all the responses. I've always been the "save for it" kind of shop. Like contributor A, I own everything including the shop building, so leasing is kind of a foreign idea to me. I guess the next stop will be the accountant/financial guy to see which way looks best from that point of view.
From contributor U:
If you can get the money from a bank because you have good credit, then I would look at the total payback between the lease and the bank. With my bank it is simple interest, so I can make a larger payment than required and lessen the interest charges. With a lease you owe the total amount even if you pay it off next week. It is easier to get money from a lease company but not necessairly less expensive.
From contributor L:
Make the list and take it to the bank, show an amount of your risk (down payment) and you will be shocked as to how much the bank will save you vs. a leasing company.
The most important thing is to step back and look at what you need to be more productive for a certain timeframe. Our's is going to be five years. Take a note out for those five and buy what you need and term it out. We are watching hand power tools, trucks and machines reach their max in our high production environment and determined an outlay for the next five years and it will replace all that worn out stuff. The monthly payment will be offset just in what it is taking to keep the slider cutting square every two weeks.
From contributor Y:
I've looked at leasing several times for major items. It was always more expensive than a bank loan. If I do well I can pay down the bank loan quicker. Not true with leases. If I don't do well, I can renegotiate the terms with the bank - not true with most leases.
"Definition of lease - A written agreement under which a property owner allows a tenant to use the property for a specified period of time and rent."
"Capital lease - The long-term lease of a capital asset. To the lessee, a capital lease is the same as owning the asset. Accounting rules require that the leased asset and the present value of the lease payments be recorded on the lessee's balance sheet. For the lessor, a capital lease is treated as a sale of the asset. Also called financial lease."
From contributor P:
The downside to a lease is that you have to make the payment every month. The upside is that you can have equipment that can improve your craftsmanship, increase production, keep work in shop instead of outsourcing and worrying about the product that you have no control over. You have to know how much you can afford and how much you can save with having the equipment that you will lease. To worry about slow times is a reality today, but it is also a challenge to know how to change with the times to make money, and leasing the right equipment can put you above the competition. I just leased a new planer at 6% and I can pay off the lease after one year with no penalties.
From contributor B:
I have been looking at a machine and the dealer gave me a lease proposal. I asked, "Leases are pretty brutal, aren't they? Aren't you required to pay the entire term with no early payoff ability?" He asked how long ago did I lease. He indicated that today's leases are much different, and you can pay off early, double up on payments, etc. That does not address the fact that banks may be cheaper, but according to him, leases are very flexible.
From contributor M:
I am an account executive at an equipment financing company. Let's look at a bank loan and a lease from 5 different aspects.
1- Interest rates: With a lease, the interest is fixed over time and starts at the prime rate. A bank's interest can fluctuate with the market.
2- Time to get approved: With a lease it takes an hour to get an approval for 150K by just filling out one single page application. With a bank it could take up to weeks to get through all the paperwork and get approved.
3- Cash/credit consequence: A lease allows conservation of working capital and adds another line of credit for your company (allows increased borrowing capacity in the future); a bank also conserves your money but decreases the lines of credit, hence how much money you can borrow in the future.
4- Down payment: Usually with a lease it's first and last months' payments. A bank loan requires anywhere from 10-20% of the amount requested.
5- Tax consequences: True lease allows for 100% of monthly payment to be expensed. With a bank loan, only the interest can be an expense, not the equipment cost.
From contributor Y:
5- "Tax consequences: true lease allows for 100% of monthly payment to be expensed. With a bank loan, only the interest can be an expense, not the equipment cost."
But under today’s tax laws, I think you can deduct up to $125,000+- right off the top of your profit for the year. If you don't have that much profit, you can carry it forward. Huge advantage for an outright purchase (with or without a bank loan!). The exact number of dollars has varied each year and will likely be done away with when the new administration takes over. Ask your accountant.
