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A guide to the pros and cons of equipment leasing for small businesses

Posted by Tasnim Ahmed

April 15, 2022    |     5-minute read (898 words)

Depending on the circumstances, leasing equipment for business can be a viable alternative to buying and investing in that equipment outright. For businesses that are new, cash strapped or that have a finite requirement for equipment, leasing can be an appealing option, akin to having your cake and eating it too. 

Most of the time, office equipment, field equipment and mining equipment are expensive and require significant cash outflow. Sometimes it is simply not feasible for a small business to invest and buy everything upfront; in these scenarios leasing can be a lifesaver.

Take for instance a scenario in which your business requires innovative technology and costly equipment with a shelf life of a few months or years. In such situations, leasing provides a way forward as it allows you to obtain updated equipment as needed without a permanent ownership obligation. 

With leasing, you know the amount that you have to pay over a period of time, and you know it will be the same for a designated period of time. This facilitates better budget planning as you already know your cost outlays.

What is equipment leasing?

Equipment leasing is a type of transaction where you pay rent on your equipment rather than purchasing it outright. Typically, it is for an assigned period of time and comes with predetermined costs. After the lease period is over, you may return the item or buy it from the vendor. 

Important: Leasing equipment is quite different from financing equipment. In financing equipment, businesses take out a loan and purchase the equipment while paying back the payment amount with accrued interest. In such cases, the equipment itself is the loan collateral. 

Whereas in equipment leasing, installment payment usually comprises the rental fee, interest and any other costs subject to the agreement between the lessee and the lessor. In monetary terms, leasing turns out to be a more costly transaction for the lessee. However, for new businesses with limited access to funds and for businesses that require new technology at a high consumption rate, leasing can be a wise decision.

Is it right for your business?

When a company decides to lease equipment, they start by searching for vendors or companies who lease the equipment they need. Once that is settled, they will either engage the help of a lease broker, a leasing company or an independent lessor to initiate the lease. 

A lease agreement is typically drawn up between both the parties wherein the terms are established. It defines the period of time for which the equipment will be used, the payment that the user will pay to the owner of the equipment, the condition in which the equipment will be kept and other information deemed important by both parties. 

Once the deal expires, the equipment is returned, or the lessee might have the option of purchasing it at a price below market value. Your business’s credit score normally determines the amount of APR you pay on the equipment and your lease terms. However, leasing does not appear on your credit report, as it is not a loan. On the bright side, you will likely be able to claim the equipment lease as a tax deduction. 

Pros of equipment leasing:

Cost controls – It does not require a large down payment.

Updates can be done quickly – If you need to frequently upgrade your equipment, leasing is an excellent alternative because you don’t have to work with outdated equipment.

Avail new equipment for short periods – If you want to keep the equipment for at least four to five years, purchasing or obtaining a loan is preferable. However, if you don't need the equipment for long or are unsure whether it is right for your business needs, leasing it is a wise decision.

Simplifies the ability to scale up – If you need to upgrade to more advanced equipment, for example to accommodate a huge volume of work, you can do so without having to sell your current machinery and buy new equipment.

Fixed interest rate versus floating rate – If you have to decide between equipment leasing and equipment financing, note that equipment leasing offers more interest rate flexibility.

Tax credits can be availed – Equipment leasing’s benefits may include tax incentives, although it depends on the particular lease.

Cons of equipment leasing:

More interest paid – In the long run, the equipment becomes more costly than the new sticker price it would have warranted had it been purchased outright.

Hidden costs – Some vendors add unanticipated costs such as mandatory maintenance programs, insurance and the like.

Lease term is final – If your work moves in a different direction and you no longer need the equipment, you will still have to make payments as the lease agreement still stands. 

It is not a business asset – Based on your equipment lease, you may not be able to deem the equipment as an asset. This could have repercussions when seeking a business loan or business valuation.

Wrap-up

Most businesses today move at breakneck speed. With an outright equipment purchase, the equipment starts depreciating the minute it leaves the store. This, in conjunction with the fact that technology is quickly evolving, implies that purchasing equipment risks becoming a burden in the event it becomes outdated and requires replacement. Research and paying your due diligence must be conducted before executing the decision as to whether to lease or purchase equipment.

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