Basic Issues to Consider When Equipment Leasing

By Randall Orser | Small Business

Big or small, when purchasing new equipment (such as tools, forklifts, furniture, computers, copiers, etc.), there are basic issues you need to consider. This can from the confusing selection of financing options, to the potential drawbacks.

The first thing to think about is whether to buy the equipment outright, with cash on hand or a line of credit, or lease it from your bank, leasing company, equipment distributor, or manufacturer.

You require much less cash up front when leasing, sometime even 100% financing is available, and is permitted under your loan agreements with your existing bank. Your monthly payment is generally lower when leasing rather than purchasing outright. The reasons are:

  • Leasing companies offer longer lease terms than that of a bank equipment loan.
  • You only pay for the right to use the equipment during the lease term, usually shorter than the equipment’s total useful life.

The flexibility of leasing is also better as you usually have three options at the end of it:

  • Buy the equipment, a buyout amount or percentage is usually specified in the agreement
  • Continue leasing, or finance the buyout with a term loan
  • Return the equipment, using it as a trade-in on new equipment

Analyzing Your Budget

You need to look at your budget when it comes to new equipment. Looking at your cash flow, what size monthly payment can you afford. Some additional issues to think about:

  • Is your cash flow seasonal? (your payments may be able to be structured)
  • Is this a one-off purchase, or a series of purchases over time?
  • What added revenue or profit will the new equipment produce?
    • Does the new equipment allow you to bid on larger jobs, or finish them more quickly to increase revenue?
    • Are maintenance costs reduced compared to the old equipment?
    • Can you improve productivity, allowing you to let go of employees?

Choosing Your Leasing Company

You have several choices to choose when picking a leasing company: bank, a leasing company, or an equipment manufacturer/distributor (also called “captive” lessor).

Bank financing is usually the most expensive; however, it may be easier as you already have a relationship with them.

The leasing company offers the most flexible terms, and is the best bet if you’ll need a large volume of leased equipment over time. A leasing company has consulting services for asset management, and can help you construct a long term leasing strategy.

The least expensive financing is captive lessors, however, give fewer choices as they’ll only finance the brands they represent.

Don’t Forget the Taxman

There are two kinds of leases in Canada: operating lease and capital lease.

Operating Lease

In an operating lease, there is no asset controlled by you as you only have the right to use the asset during the lease term. Therefore, the asset is not considered yours, and will not show up as an asset on your balance sheet; only the lease payments will show up as an expense on the income statement.

Capital Lease

In a capital lease, you are deemed to have the benefits and liabilities of ownership for the lease term. This is based on the length of the lease, total lease payments required, and the buyout amount at the end. The asset will show up on your balance sheet; however, for tax purposes there is no deprecation. You can deduct the full cost of the lease payments, interest and principal.

Settling the Lease Documents

Since commercial leases are never written in plain English, like a consumer car lease, you are best to hire a lawyer to review them. Do this even if the leasing company says they’re just standard forms, or not negotiable. Commercial leases are not subject to consumer protection laws.

Certain sections that you should be paying attention to include:

  • Early termination penalties
  • Who pays for delivery, and can you return defective equipment?
  • Are payments before the lease used as collateral, then credited at the end?
  • What’s the buyout process at the end? Does the lease automatically renew?
  • At the end of term, how is equipment returned? Who pays for storage and delivery? What does ordinary wear and tear mean?
  • Will sales tax apply? Who Pays? Which sales tax rate is used?
  • Can the leasing company assign your lease?
  • What happens if you default? What are the leasing company’s remedies?

Your lawyer can also determine whether you can lease under your current bank loan financing, and if you need to get the bank’s consent for the lease

Checking into your financing options, and assessing the value of leasing over purchasing will pay off in the end. What’s best for your bottom line is getting that upgrade or adding new equipment so you can grow.

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