How Businesses are Saving Money by Leasing Equipment
Are there any strategies companies can borrow from personal finance? In essence, can companies adopt simple personal finance strategies when looking to improve how they manage their business? In fact, they can. There are two essentials of successful personal finance; purchase appreciating assets and lease depreciating assets. The same holds true for successful business management. Leasing large capital expenditures reduces a company’s costs of capital by allowing it to lower the costs of that purchase over time. After all, today’s enterprises must be able to handle the high costs of financing inventory and receivables amid an economy where demand is low, and customer payment delinquency is high. So what are some of the benefits of leasing over purchasing, especially when it comes to large capital expenditures, ones that can’t be treated as a onetime expense?
Cash Flow: Leasing allows companies to keep more money in their business, which in turn allows them to lower their overall costs of purchase. A strong cash position is essential in order to ride the highs and lows of a company’s seasonal business cycles. Maintaining more cash in the business allows companies to reduce their costs of capital by lowering their borrowing costs. In essence, it allows companies to protect retained earnings by not using those earnings on a large purchase of equipment or machinery.
Lower Overall Tax Rates: Leasing large purchases allows companies to capitalize equipment and machinery by treating the expenditure as a non-cash expense. This allows companies to use the depreciation value of their purchase each year to lower their earnings, which in turn reduces their overall tax rate. Capitalizing equipment and machinery is preferred because it often involves a large amount of capital. A capitalized asset is any fixed asset that can’t be converted into cash within a period of one year. Since large expenditures on equipment involve substantial cash, companies choose to capitalize the asset over time, rather than treat it as a onetime business expense.
Lower Financing Costs: There are several simple and straightforward leasing options, all with the aim of lowering a company’s costs of financing large purchases. However, these options are often represented by two main leasing categories or contracts; a finance lease and an operating lease. A finance lease means the company (lessee) inters into a long-term contractual agreement with a financing company (lessor). The terms are considered fixed for the duration of the agreement. An operating lease is shorter in duration and more flexible in terms of the lessee’s ability to opt out of the contract. Both have different payment plans, financing costs and conditions. However, it’s important to note that a finance lease implies the company benefits from ownership. The company is paying down their purchase over time in the aims of owning that purchase outright. An operating lease implies that the lessor retains all ownership rights. In this case, it is shorter in duration and more flexible for the lessee. In essence, a finance lease is considered a purchase for the company, whereas an operating lease is considered a services contract, one where the lessor retains all ownership of the asset.
Companies can use leasing across their entire operations; they can lease everything from office equipment to warehouse equipment, thereby reducing the high costs of obsolescence. Leasing allows companies to improve their service capabilities by having the option to upgrade existing purchases. Finally, leasing is preferred because of its tax advantages, as companies are able to lower their earnings on “paper” and benefit from a lower tax rate.