What is the buy-out at the end of the term and what are my options?
Isn't my company better to pay cash or borrow rather than lease?
Are there any tax advantages to leasing equipment rather than buying for cash or borrowing?
Interest rates for leasing are affected by market conditions differently than mortgage and personal or business lending. Asset-based finance offers little opportunity to realize gain on the value of the asset consequently the time value of money is the key to calculating rates and payments.
Contrary to popular belief, equipment leases are free from penalty if paid up. The usual requirements to early pay a lease are the balance of payments (including taxes) plus the buy-out option (plus taxes). Auto leases often carry an interest penalty to early pay.
The schedule for payments is set when the lease agreement is signed. Changes are generally impossible, however, arrangements to accommodate seasonal or other special circumstances can be set up during the approval process.
To qualify as a lease, there must be a Fair Market Value or buy-out at the end of the lease term. This amount is usually 10% of the initial value of the equipment. Buy-out values less than this can make the lease payment ineligible as a business expense - the process is likely to be treated as a capital lease that imposes the need to depreciate over a specified schedule at a pre-determined rate. Usually the options include: a) pay the buy-out amount plus taxes; or b) trade-up the equipment for the newer model.
Borrowing to purchase equipment makes the transaction a capital expense that allows the deduction of interest, depreciation and insurance costs. Cash purchases are treated similarly without the interest deduction. Leasing usually allows a full expense deduction for the monthly payment including taxes. This enables writing down the purchase over the term of the lease. Additionally, retaining cash in your business means that inventory and other necessities can be bought. Finally cash in the bank earns interest - interest that can be used to make lease payments.
To qualify for a standard lease, a business must be in operation for at least 2 years with a good credit record. Depending upon credit department requirements, financial statements may be requested to secure approval for high credit limits, usually in excess of $35,000. It may be possible to secure leasing for a newer business through personal guarantees of principals of the company.
Equipment leasing offers the following tax advantages: a) monthly payment is a deductible expense, b) faster tax write off than capital cost allowance, c) improves cash flow, and d) lower cost of acquisition than borrowing or paying cash.
Whether or not a business has money, leasing can be a viable alternative to traditional financing. When expenditure restrictions are imposed, needed equipment can be acquired via leasing. Since leasing usually is 100% financing, other lines of credit can be protected and avoid the need to pledge inventory or receivable assets. Leasing can enhance a business' credit ceiling or assist in establishing credit for a new business.
Lease finance conserves capital - leased equipment leaves capital available for raw materials, inventory, advertising, work in progress, or cash that may avert hardship should a crisis occur. Leasing can protect existing lines of credit by avoiding the need to pledge existing assets such as inventory or receivables as security. Once a lease is in place, the monthly payment is fixed unaffected by general interest rate changes. This facilitates budgeting when equipment and operating costs are stable. Rather than seeking approval for a large capital cost, often it is easier to secure approval of a small monthly payment. Vital equipment can be acquired without the delay of budget process or head office approval.