Most business owners
spend considerable time analyzing and trying to improve the cash flow
of the business for day-to-day operations and for growing the business.
One method of improving a company's cash flow is to lease necessary equipment
instead of buying it outright. This saves an initial outlay for the entire
cost of the equipment and spreads it over some term with a built in interest
cost. Equipment leasing is a very common way many small business owners
help capitalize their business and manage their cash flow.
How does it work?
An equipment lease is a contract between the company (lessee) and the
financing company (lessor). The financing company may be a bank, leasing
company or the equipment manufacturer. The contract commits the company
to make monthly payments over a period of time for the use of the equipment.
It may also include an option for the company to buy the equipment, for
some stated price, at the end of the lease. The amount of the monthly
lease payment is based:
- The purchase price
of the equipment.
- An interest rate
built into the payments.
- Term of the lease.
of the lessee.
- Estimated residual
value of the equipment at the end of the lease.
There may be some
initial "down payment" on the lease. During the lease period,
usually the company has the obligations for maintaining and insuring the
equipment. At the end of the lease, depending on the terms, the lessee
may buy the equipment or just let the lessor take it back.
Pros and cons of
- Any initial down
payment will, of course, be less than the total cost of the equipment.
This immediately reduces cash outflow.
- Lease payments
can be tax-deductible business expenses. If you own the equipment outright,
there would be annual depreciation expenses.
- The lease approval
process is usually relatively quick.
- The amount of
paperwork may be less than that required for a business loan.
- If the lessor
is also the equipment vendor, the lease may have a lower interest rate
built into it than what would be used by an independent leasing company.
- An option to purchase
at the end of the lease gives the business the right and not the obligation
to purchase. This choice can enable the business to reduce the risk
of ending up owning a piece of obsolete equipment.
- Some leasing companies
may also require a personal guarantee of the lease by the owner of the
In evaluating whether
to buy or lease, make sure to weigh the benefit of improved current cash
flow against the cost of money (the interest rate) built into the lease.
If leasing makes sense for you, this method of financing can be a very
good way to grow your business.