It can be hard to know the best financing solution for your business or project. Whether you are expanding your office, manufacturing capacity, transportation fleet or heavy equipment, there are things to consider when deciding whether to buy or lease.
There is a lot of flexibility with lease structuring when compared with other kinds of financing. Leases can be structured as debt financing, called capital leases, or they can be structured as true rental contracts, called operating leases. The terms of repayment typically range from 24 to 60 months and can be specifically tailored to meet your business’ tax, accounting and cash flow requirements. In order to understand the benefits of these two general types of structures, it may be helpful to consider them separately.
A capital lease means that the lessor transfers the rights of ownership to the lessee and the property is recorded as an asset in the business’ general ledger. The debt obligation is also recorded.
What are the specific benefits of capital leases?
• Leases generally do not require a down payment. Financing through a lease typically includes freight and soft costs and can be included with the amount financed.
• Leases favor the lessee’s ability to borrow in the future. There are not additional covenants that restrict your ability to borrow. They are structured so the ability to make the payments and the collateral of the equipment is what secures the transaction.
• Leases can be structured to improve cash flow for your business. Sometimes lessors can structure the lease with uneven payments or balloons to coincide with the lessee’s business cycle. Think of a ski resort.
• Many times loans have variable rates. Leases typically have fixed interest rates, which can reduce uncertainty for business owners.
• Leases do not typically have points or draw fees associated with them. Generally, when you get a new loan, you will be required to pay fees or points. Leases don’t usually have fees or points.
An operating lease is treated as a rental contract from an accounting perspective. This means that there is no debt or asset on the balance sheet and the entire amount of the rental payments are recorded as a business expense on the income statement.
What are the specific benefits of operating leases?
• The above listed benefits for capital leases are also benefits for operating leases.
• There may also be tax benefits for lessees with an operating lease. Make sure you talk to your accountant or a qualified tax expert. Lessees may be able to claim the entire rental payment as a tax deduction as opposed to depreciation and interest expense. This can be beneficial in terms of timing and the resulting present value of the tax deductions if the lease term is shorter than the corresponding MACRS schedule. This timing benefit sometimes doesn’t apply if there is a bonus or accelerated depreciation available to the lessee.
• Because operating leases are considered rental contracts, debt is typically not recorded on the balance sheet for operating leases. Again, make sure you consult a qualified tax and accounting expert for correct tax and accounting treatment. The actual treatment will depend on the ruling of the lessee’s accountant.
• Keeping the debt off the balance sheet may be helpful in a number of ways. It may improve certain financial ratios. It may also keep the business within the covenants of their primary bank and help improve that relationship.
There are also specialty lease products for some industries and equipment. You can always talk to your banker or a lease professional about what might be the right product, lease or loan when you need financing.
Jason Price is the president of GrowthFunding Equipment Finance in Riverton.