3 reasons to lease equipment

With the new year beginning, it is a good time to go back to basics and review as well as quantify why it’s a good idea to use a leasing option for new and used equipment.

The reasons for keeping money in the corporate bank account are no different in a slow economy than when it is booming: Cash always is king and, therefore, maintaining a solid cash balance always is preferred regardless of market conditions.

Here are three reasons why I recommend equipment lease financing to Canadian manufacturers:

1. Operating Leases Are a Tax-friendly Transaction

When a piece of equipment is bought outright, either with cash, a bank loan, or a line of credit, the buyer takes immediate ownership, and the equipment becomes an asset on their balance sheet. From a taxation perspective, the benefits of ownership allow the company to depreciate the asset, which essentially is expensing a percentage of the equipment’s cost to reduce operating income and pay less tax.

However, if the purchase happens near the end of the year, tax savings could be minimized if the CRA does not allow a full year’s depreciation to be used.

From a tax minimization perspective, a favoured method to handle this kind of transaction is to set up an operating lease. This is a contract that allows for the use of an asset but does not convey any rights of ownership. The leasing company maintains ownership of the asset. The equipment is not put on the books as an asset but instead accounted for as a rental expense in what is known as off balance sheet financing and does not result in assets or liabilities being recorded on the company’s balance sheet.

There is no doubt that the lowest cost of funds always is a bank loan. However, the differences can be minimal. As an example, if a five-year lease is arranged for a $100,000 machine, the monthly payment is roughly $2,000. But when arranged with a bank, the payment may be closer to $1,900. When tax savings is taken into account, the monthly difference could be less than $40 if a full year of deprecation is used.

This is relevant because a typical leasing company can respond very quickly for a transaction of this size. No more than one or two business days are needed, compared to a much longer timeframe from a bank. This can be critical because of limited equipment availability and the need to act immediately when an opportunity arises.

2. Lease Equipment and Use Cash Where It Earns the Best Return

Machinery and equipment are by nature depreciating assets. Even the finest Japanese or European machine tool has its maximum value the day before it is installed. A sharp business owner uses their funds for investments that provide the greatest return, which normally is found by reinvesting in their own business. An example of this is hiring an additional salesperson.

Many of my most successful clients are owner/operators so they are running the shop and making sure good parts are delivered to their customers when promised while also handling all of the proposals, quoting, and estimating. They function as both the sales manager as well as the plant manager, two roles that often are best handled by two different individuals.

Depending on the business, it makes a lot of sense to hire or promote someone to handle the plant manager role. I can tell you from first-hand experience that business development is a full-time job and also one that provides a great return.

Investing in your business always is the best use of funds and is something that cannot be financed.

3. Leasing Allows Companies to Increase Borrowing Capacity Significantly

A leasing company has no intention of replacing your bank.

Many of my clients have well-established banking relationships complete with large operating lines that they properly use for short-term debt like financing receivables or covering short-term costs like buying tooling and material.

They use equipment leasing as a complement to their bank and match lenders with their debt requirements to avoid tying up valuable bank lines or working capital in long-term needs like machinery and equipment.

I also have clients that don’t qualify with their bank for a large purchase, like a piece of manufacturing equipment. This just means that from a financial perspective, the bank doesn’t think the company can support a transaction of that size.

Buying the latest technology is a very expensive proposition. Despite the fact good equipment—when maintained properly—will run in a plant for more than a decade, it still is a significant cost and can be challenging for a typical banker to understand.

When we hired a credit analyst who came from a chartered bank, I got a first-hand account of how they review asset purchases. What I learned was they essentially look at the asset, whether it is a machine tool or a trailer, and assume they will recover about 20 per cent of the original value of the asset should the deal go bad.

A leasing company with expertise in machinery and equipment looks at the exact same transaction and knows that the recovery amount is much higher and can approve the transaction because its perceived risk is significantly smaller.

I have tried to outline the importance of taking a few additional factors into consideration when deciding how best to arrange financing for a large transaction. There certainly must be a dollar-and-cents attitude when making this decision, but all the relevant aspects, such as tax implications, internal ROI, and an increased borrowing capacity, also should be considered.

Ken Hurwitz is vice-president of Equilease Corp., 416-499-2449, ken@equilease.com, www.equilease.com.