Most business owners spend considerable time analyzing and trying to improve the cash flow of the business for day-to-day operations and for growing the business.
One method of improving a company's cash flow is to lease the necessary equipment instead of buying it outright. This saves an initial outlay for the entire cost of the equipment and spreads it over time with a built-in interest cost. Equipment leasing is a very common way for many small business owners to help capitalize their businesses and manage cash flow.
How does it work?
An equipment lease is a contract between the company (lessee) and the financing company (lessor). The financing company may be a bank, leasing company or the equipment manufacturer. The contract commits the company to make monthly payments over a period of time for the use of the equipment. It may also include an option for the company to buy the equipment, for some stated price, at the end of the lease. The amount of the monthly lease payment is based on the following:
- Purchase price of the equipment
- Interest rate built into the payments
- Term of the lease
- Creditworthiness of the lessee
- Estimated residual value of the equipment at the end of the lease
There may be some initial down payment on the lease. During the lease period, the company usually has the obligation to maintain and insure the equipment. At the end of the lease, depending on the terms, the lessee may buy the equipment or just let the lessor take it back.
Pros and cons of equipment leasing
- Any initial down payment will, of course, be less than the total cost of the equipment. This immediately reduces cash outflow.
- Lease payments can be tax-deductible business expenses. If you own the equipment outright, there would be annual depreciation expenses.
- The lease approval process is usually relatively quick.
- The amount of paperwork may be less than that required for a business loan.
- If the lessor is also the equipment vendor, the lease may have a lower interest rate built into it than what would be used by an independent leasing company.
- An option to purchase at the end of the lease gives the business the right but not the obligation to purchase. This choice can enable the business to reduce the risk of ending up owning a piece of obsolete equipment.
- Some leasing companies may also require a personal guarantee of the lease by the owner of the business.
In evaluating whether to buy or lease, make sure to weigh the benefit of improved current cash flow against the cost of money (the interest rate) built into the lease. If leasing makes sense for you, this method of financing can be a very good way to grow your business.