We have all heard about how the economy has taken its toll on most businesses. Probably the hardest hit has been the manufacturing sector. In such uncertain economic times, Contractors can benefit from equipment leasing, a financing practice that has been around since 2000 B.C.
Leasing equipment can help your business survive these uncertain times and also prepare you for the next boom. Leasing helps you to manage your cash flow, guards against obsolescence, increases financial flexibility and may reduce your tax burden. These advantages can apply to most any equipment, from a blast furnace to a new computer system.
Why Companies Lease
The Equipment Leasing Association surveyed small and medium size businesses, and asked them to list reasons of why they decided to lease rather then buy equipment. (Graph A)
- 35 percent stated Cash Flow as the primary factor - This may be especially important in the commercial contractor industry.
- 17 percent sited Dollar Value - Leasing offers fixed rate financing so payments remain the same throughout the term of the lease regardless of interest rate fluctuations.
- 13 percent said they preferred the Convenience and Flexibility - There are endless ways to configure a lease. For example, it may take months for your new equipment to operate at peak efficiency, so a lease may be set so there are no payments or smaller payments for the first several months. If your business is seasonal, the lease can be structured with variable payments.
- 13 percent claimed Taxes were the main attraction. - A lease can be structured as an operating lease so payments are totally tax deductible and the lease obligation remains off balance sheet.
- 13 percent of the companies preferred Maintenance Options - Maintenance costs can be included in the lease, therefore reducing maintenance cost variations.
- Nine percent felt leasing helped them stay abreast of Latest Technology - If the equipment is no longer useful to your business at the end of the lease, the lessee may choose not to exercise the lease-end purchase option.
There are also other considerations that may be pertinent to the commercial industry:
- Expanded credit availability - Leasing normally doesn't impact your bank credit relationship, preserving your banks credit availability for short-term credit needs. Also, if a lease is structured as an operating lease, the lease obligation may not affect leverage ratios in bank loan agreement covenants.
- Section 179 of IRS Code - This rule allows total annual deductibility of up to $108,000 annually for qualified equipment purchased or leased through a capital lease. The one catch is that the company's total equipment expenditures cannot exceed $200,000 for the current tax year.
- Circumventing budget restrictions - Many companies consider a lease an expense item and not requiring a capital budget review process.
Types of Leases
1. Operating Lease - This is the typical "Off Balance Sheet" lease. It is typically a shorter-term lease and frequently is on equipment that there is a high likelihood of being jettisoned when the lease ends - high tech equipment, computers and high-use copiers. It answers four criteria as established by Financial Accounting Standards Board (FASB):
1) Ownership of the property does not automatically transfer to the lessee at the end of the lease term
2) The lease does not contain a bargain purchase option
3) The lease term is less then 75 percent of the useful life of the equipment
4) The present value of the lease payment is equal to less then 90 percent of the cost of the equipment.
Under this scenario, the payments are an expense and no asset or liability is recorded on the balance sheet. The accounting profession is playing with these standards; within the next five years there may be no off balance sheet transactions. If your lease meets these standards, then the payment can be expensed. Although, if your financial statements are not audited, the IRS has a looser definition of what constitutes an operation lease. Typically they will allow this treatment for any lease with at least a ten percent purchase option.