How does equipment leasing work?
Are you looking for a machine lease or a lease contract company for your next equipment purchase or just want to know “How does equipment leasing work? Are you wondering if you should go for leasing or financing your equipment? All the information you require is here. Before we can take a look at how does equipment leasing work?, let’s go through some of the reasons you should consider equipment leasing.
How Is Equipment Leasing Important to a Business?
Sometimes a business cannot buy right away the equipment it requires to operate due to many reasons such as because it’s a startup, a need to secure working capital, or insufficient cash flow. This is where equipment leasing comes in as an ideal option. There are a few types of equipment leasing such as machinery leasing, technology leasing, business equipment leasing, and printer leasing. Among other equipment you could lease include a gaming machine in a pub’s corner, plant machinery, mining equipment, or catering equipment.
How Does Equipment Leasing Work?
There is a wide variety of equipment leasing options. So how does equipment leasing work? With an operating lease, your business is allowed to utilize assets but doesn’t provide any equipment’s ownership rights. Usually, ownership is left to the leasing company or the financial institution. However, an agreement to an operating lease is usually the financing of assets in an off-balance sheet. It’s where the associated liabilities of later rent payments and a leased asset are not included on the company’s balance sheet.
A lease purchase agreement is another example of an equipment lease contract. This is where the business that leases the equipment pledges to buy the equipment once the leasing term is over. A lease option is almost the same as a lease-purchase agreement. This is cause the same business has the choice to buy the equipment either during the lease period or at the end of it.
You could also find other leasing agreements such as open-end and closed-end leasing agreements. With a closed-end leasing agreement, no money is obligated when the lease period is over. This means that the equipment can be given back without incurring additional costs. On the other hand, an open-end lease is quite different. In that small monthly payments are made and followed by a huge payment referred to as ‘balloon payment’ when the lease period is over. Although this enables your business to maintain cash flow, the last payment could cost you more than you’d have bought the equipment. In case an open-end lease is the only choice you got, it’s advisable to make sure that you don’t incur additional fees such as wear and tear.
Equipment leasing is the best option for start-ups that find it hard to acquire equipment due to their lack or little credit history. In such a situation, several equipment leasing companies take into account personal credit history throughout the approval process. There are lots of equipment leasing providers such as captive leasing companies, independent leasing companies, distributors and equipment dealers, brokers, and banks. Every option has its benefits.
Distributors and equipment dealers can assist with arranging to finance through independent leasing companies. On the other hand, brokers ask for a small fee to act as the lessors and lessees intermediary. Usually, the lessee is required to provide the latest standard identification documents and a set of business accounts.
The Costs Involved In Equipment Leasing
The equipment’s final cost could end up being more than if the equipment was bought right away. For a lease option, a premium is most likely going to be offered to have the chance to purchase the equipment. If your business doesn’t employ that option, then the premium is deemed nonrefundable.
Just like with any kind of finance, it’s essential to thoroughly go through the lease agreement before being committed to it. You could compare the leasing costs to the present interest rates to find out whether the terms are good. You could also compare the leasing costs of buying the equipment right away since it might turn out that it’s cheaper or convenient to take the instant financial hit.
How Long Does Leasing Take To Arrange?
Depending on the amount of capital in play and the type of leasing, commercial equipment leasing companies take as little as a day to respond to your application. This is, of course, if your credit application has all the needed information.
What Kind of Security Do I Require ?
Little security is required since the lease agreement is protected by the leased equipment. Also, businesses that have assets but are experiencing financial difficulties can borrow against that equipment by making use of asset financing while going on with their use.
If you are looking to buy something that won’t require regular updating such as a pizza oven, it’s prudent to go for equipment financing where you can buy purchase the item right away. It is usually relatively easy to be qualified for equipment loans. The amount of cash you’ll be considered eligible to borrow depends on the particular kind of item you are planning to buy, and if it’s new or used.
Since the item you are buying can normally be used to acquire the loan, you’ll rarely be requested to give out any additional collateral. However, these types of loans are accompanied with fixed interest rates of around 8% to 30%. Therefore, it’s important to always keep in mind that even though acquiring a loan may seem affordable at the moment, you’ll end up paying more.
Unlike equipment leasing, the loan you apply won’t be affected even if what you’re purchasing eventually becomes obsolete. This means that when your payment plan is over, you could be spending money for an item that is no longer of service to you.
After having an idea of what equipment financing and lease are all about, some of us can’t help but wonder how does equipment leasing work to your advantage over equipment financing? What are the pros and cons of equipment financing? Below is a list of some of the advantages and disadvantages of both equipment leasing and equipment financing.
Benefits of Equipment Leasing
- You don’t have to be bothered to look for more money – With a lease, you can rent a particular piece of equipment that seems financially impossible for you to buy right away. Usually, you won’t be requested to make any kind of upfront payments. Also, the monthly rate involved is generally lower compared to what you would find out attached to a line of credit or business loan.
- The Flexibility of Cash Flow – Using your working capital for purposes of updating or buying equipment might not be a wise idea, particularly if you’re already low on cash. With no down payment required to get a lease, you’ll have extra money to take care of your bills, purchase inventory, and make payroll.
- Being up-to-date with technology – For those in a technology-related field, it’s easier to understand that your piece of equipment should be the best in the market. It wouldn’t make any financial sense to keep on replacing it after a few years. In case you realize that you’ll need equipment upgrades constantly, leasing would be a more considerable option compared to buying.
What happens to the equipment at the end of the lease?
It’s not your obligation to buy the equipment once the lease period is over. So you could return an outdated piece of equipment once the contract is over and open another lease on another newer item. In other cases, you can have the option to trade out your item in the middle of your agreement if the items you were using gets outdated.
- Tax Incentives – The lessee pays some periodic rentals that are regarded as revenue expenses when calculating taxable profits. Therefore, a benefit to a lessee who can reduce his or her tax liabilities.
- More suitable than a term loan – Usually, equipment leasing companies take a relatively shorter time when processing your lease contract. This time tends to be lesser compared to the time taken to process an actual term loan. This makes leasing a more suitable source of finance than a term loan.
- Low Maintenance Cost – Depending on the agreement of the lease, sometimes the lessor can offer the lessee some specialized services. The lessee can offer these services to maintain a particular leased asset. Usually, the lessor charges via increased rentals for these kinds of specialized services.
Are Equipment Lease Payments Tax Deductible?
You often get loans from for cars and houses. They charge you a specific interest during your payback period. But what if you want to buy an expensive machine for your business? Is it still okay to take a loan, or instead, leave the equipment? Experts believe that leasing a machine has different tax implications compared to buying the equipment in the first place.
Tax advantages of equipment leases
There are two financing options when you plan to buy a machine. You either buy it or lease it, depending on the money you have right now. However, your decision will also have an impact on the amount of taxes also. So, let’s take a look at both the options:
- Buying the equipment
The first option involves paying for the equipment in full. It is a sensible choice for many because they have the money. However, buying the machine would also mean evaluating its depreciation. The government decides the depreciation rates of different machines. By the time you collect the entire depreciation value with your yearly tax deductions from the government, it will be time for the equipment to become obsolete.
- Leasing the equipment
The second option involves leasing the machine. This is more like paying an expense instead of buying the machine using up the entire cash. It would not involve depreciation value as a capital cost. Most importantly, lease payments are tax deductible. So, you don’t have to pay additional tax at the end of each year for the machine. Leasing doesn’t involve paying taxes for the equipment against your income for the entire lease term.
There are a couple of things you need to keep in mind when it comes to leasing a machine to make it tax deductible.
• You can write off a machine that depreciates over time quicker. This is not always possible if you buy the equipment. Cash is always the king in a business. So, leasing will help you get your money back into the company as soon as possible.
• Leases on machines don’t have up-front costs, such as PST or GST.
As already mentioned, leasing an equipment has various tax implications, and the IRS can recharacterize the lease as a sale. Here are some of the factors that may lead to the recharacterization:
• A part of your rental payments for the machine creates equity.
• You acquire the title of the machine after paying a specific lease amount.
• You make lease payments within a short period, and this amount is more compared to the amount needed to buy the machine in the first place.
• Your lease payments are substantially higher than the fair payment value of the machine.
• You make a part payment for the lease of the equipment as interest.
If you enter a lease agreement with any of the clauses above, you should be extremely careful to avoid penalties because the IRS can recharacterize the transaction. Other than that, you can be assured that leasing a machine is tax deductible with minimal complications.
Disadvantages of Equipment Leasing
- Higher Cost – Periodic rentals are paid by the lessee to the lessor and they also include the lessor’s margin. This is mainly because the leased asset has a certain risk of obsolescence. Hence, equipment leasing is usually taken to be high-cost financing.
- No Changes in the Asset – The asset’s owner is not the lessee, so he or she cannot make any alterations/modifications to the asset. Once an asset is purchased, the buyer can then make changes to the asset depending on his/her requirements.
- Penalties – The lessee is generally required to make some payments to the lessor in case he or she decides to terminate the equipment lease contract before the end of the lease tenure. The penalties payment is a con for the lessee.
- Restricted Asset Usage – There could be a risk that the lessor might limit the lessee in using the leased asset. In such a situation, the lessee might miss out on the full utilization of the item. This may happen if the lessor’s financial position is weakening.
Benefits of Equipment Financing
- You don’t have to be bothered to look for money – If your business is lacking some extra money to use, applying for a loan is an excellent way of assisting you to find the piece of equipment you require without the need of incurring some of the upfront charges of a purchase.
- Less Documentation – For a more traditional loan, banks or other lenders request to see a good decent score, years of financial history, alongside other documentation. On the other hand, lenders don’t pay much attention to your financial history and your credit score with an equipment loan. This is especially true since the equipment you are buying will be applied to secure your loan.
- Tax Incentives – For those thinking about to finance their equipment, the highest annual tax deduction is now set at $500,000. This means that for small business owners, financing is often completely tax deductible.
- Full Ownership – Once the loan has been fully repaid, you can have full ownership of the particular equipment. This is especially beneficial for an item that has a long shelf life span such as office furniture, restaurant, and farm machinery, unlike other items that could easily become technologically obsolete.
- Flexible payment scheme – Of course, your payment scheme will rely on your lender. Ensure you build up a great relationship with your particular lender. Just by asking, you should be in a position to get a flexible payment scheme. This could range from monthly to even annually.
Disadvantages of Equipment Financing
- Restrictive – Just like the name suggests, this particular type of loan is meant for equipment only. So if you require the funds for another purpose, then you won’t stand a chance to use your particular equipment loan.
- Full Ownership – Yes, this is also a disadvantage. For equipment that quickly depreciates such as software and computer, it’s prudent to go for equipment leasing instead.
- Generally More Expensive – Considering equipment financing will cost you more than buying the item outright, mainly because of the loan’s interest. If this isn’t a problem for you, then you’re good to go! However, most businesses find these unfeasible.
Bottom Line: Which Is The Best Option? Leasing or Financing Equipment?
When it comes to choosing between a loan or a lease, pay more attention to the specific piece of equipment you want. For short shelf life equipment, go for leasing. For a piece of equipment that you’ll have around for a longer time, an easier and cost-effective choice is financing. We hope this article answered your question about “How Does Equipment Leasing Work?”
Neal Business Funding offers Equipment Financing & Equipment Leasing. For a free rate quote, call 315-699-4703 or fill out the contact form at Nealfunding.com. Of course you can always email us too firstname.lastname@example.org