Leasing vs. buying equipment: What’s best for your business?
INSIGHT ARTICLE |
Capital equipment is a critical component for most construction firms, and according to recent data, the industry’s investment in equipment is going to steadily increase. According to the Equipment Leasing and Finance Association, investment in equipment by construction firms expanded in the first quarter of 2017 by an annual rate of 15 percent—the first increase in more than two years.1 In addition, a 2017 Wells Fargo survey found that 65 percent of construction equipment distributors expect new equipment sales to increase, and nearly 40 percent of construction contractors believe their purchase of new equipment will increase as well.2
While there is no doubt about the continued need for equipment, there is one question companies should ask: Lease or buy? It’s a question that is not always easy to answer.
Like any other decision a company has to make, the choice of whether to lease or buy should be based in part on the firm’s unique financial circumstances. But there are other issues to consider before making a decision.
When a company’s cash flow is an issue, leasing can be a way to obtain equipment without investing large amounts of capital in advance. Leasing typically involves less upfront cost—usually no down payment is required—and monthly lease payments can sometimes be less than a traditional loan financing payment.
Another factor to think about is how long the company will utilize the equipment. If the equipment will soon become obsolete or will need to be replaced for a newer version in a couple of years, leasing may be preferable. Lease terms can be negotiated to allow trade-ins and upgrades as they become available.
A major consideration that could lead a company to buy rather than lease is the benefit of control over the equipment. With a lease, there may be a third party influencing maintenance and utilization decisions. If the company owns the equipment, it has complete authority over how the equipment is used and maintained.
Buying requires more capital upfront, but ownership allows the company to take various deductions for the equipment’s depreciation to reduce taxable income, including accelerated depreciation to allow for quicker recovery of the value in taxable income. By purchasing an asset, the company can list it as such on the balance sheet; any corresponding financing will be a liability on the balance sheet.
New leasing standard
While historically the choice between leasing and buying has been based primarily on cash flow, recently released accounting standards could factor into the equipment decision.
In 2016, the Financial Accounting Standards Board issued a leasing standard that will change how private companies account for their leases. Essentially, the new standard (ASU No. 2016-02, Leases, Topic 842) levels the playing field between buying and leasing, as it requires all leases that have a term greater than 12 months to be recorded on a company’s balance sheet as a right-to-use asset and a lease liability. Unlike in the past when companies could lease equipment and structure the leases so that they never had any liabilities or debt on the books, the new standards require leases to be recorded. As such, companies must take a closer look at their bank covenants as the change in leases will put additional liabilities on the balance sheet, thereby affecting their financials.
Review lease agreements
The new leasing standards will take effect in 2020 for nonpublic companies, but companies need to be thinking about the changes now and looking at any lease agreements they currently have that will soon affect their balance sheet. The new standards are also a great reminder for firms to contact their tax professionals about equipment depreciation and other details about the upcoming regulations.
While these new leasing standards blur the lines between leasing and buying on the company’s balance sheet, other considerations should not be forgotten or overlooked. Cash flow needs, asset needs and overall cost should still be major factors in the decision to lease or buy. In the end, it all comes down to what works best overall for business.
1 “Fact Sheet: Equipment Finance in the Construction Industry” Equipment Leasing and Finance Association.
2 “Construction Industry Forecast” (2018) Wells Fargo Equipment Finance.