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Updated: March 27th, 2020
For many businesses, equipment is a vital part of the operation, alongside employee payroll and marketing costs. One issue with leasing vs purchasing equipment and keeping it repaired and up-to-date is cost. Equipment is already expensive the first time it is purchased, but each repair or subsequent update only increases the price. Worse yet? Most equipment depreciates in value rapidly, meaning resale often comes at a loss.
When considering leasing vs purchasing equipment, businesses should evaluate the profit margin they will have on a piece of equipment over its lifetime. Even if the business can buy a piece of equipment outright, the profit margin on it should be considered first and foremost.
Non-essential equipment with a low traditional margin or low ROI potential may be able to generate non-traditional margin improvements. These include cases such as marketing stake, experiential value, and consumer engagement — all of which may not contribute directly to equipment-generated profits.
Equipment financing is the practice of seeking funding to cover costs for equipment. Businesses may or may not have enough cash flow to support the purchase upfront. However, even if they do, it is sometimes better to keep extra cash flow available by securing a loan. The business may pay more on equipment financing or leasing loans in the long-run, but reduced financial pressure can enable the business to continue expanding.
Equipment financing can take multiple forms including, but not limited to:
Quick turnaround time on equipment loan applications is a strong point toward user experience for business owners. Not only are entrepreneurs limited on time, many of the opportunities that come to them are also time-limited. Long delays between application and funding can prevent businesses from snapping up equipment financing and leasing deals that would have been to their benefit.
Requirements for equipment loans vary between lenders, business and owner qualifications, loan repayment term, and the size of loan needed.
Generally speaking, lenders usually evaluate prospects based on several of the following criteria:
Financing offers both free cash flow and tax benefits in addition to the value of having new equipment on-site. With equipment financing, interest on business loans may be a tax write-off — up to 100% of any interest due over the term of the loan. Some financed equipment may be eligible for tax depreciation in addition to writing off the loan interest depending on whether the property is owned or not.
The following criteria help determine whether a piece of financed equipment can be depreciated:
Loan terms for equipment purchases can extend to around 10 years, though it is not common for equipment to have an expected useful life of 10 years. Some equipment depreciation examples include computers, which experience end-of-life after roughly six and a half years. Meanwhile, commercial vehicles last an average of ten years. Conversely, restaurant equipment can be depreciated over 15 years.
Equipment loan terms will also specify the interest rate, which may exceed 20% APR. As mentioned, interest can commonly be written off, allowing business owners to reduce tax burdens for money they do not have.
Equipment leasing differs from equipment financing in the way ownership is handled. Equipment leasing loans allow businesses to essentially rent a piece of equipment, without having to front the market value for its purchase. The tradeoff of leasing vs. purchasing equipment is that after the lease term, ownership remains with the original owner, while the business can still purchase it for fair market value.
Tech companies benefit from equipment leasing loans due to the ease of keeping up with hot new trends. Companies can sometimes use leasing effectively to secure company cars, especially if they need to change cars every couple of years for appearances’ sake.
In terms of leasing vs. purchasing equipment, leasing allows startups and high equipment turnover businesses to keep up to date with the trends and retain equipment advantage over their competition without massive equipment purchase expenditures.
Leasing does not force businesses to own equipment yet it allows them to purchase the equipment at the end of the lease term. It is important to note that businesses cannot generally write off leased equipment because they do not technically own it. In the case of financing, however, businesses generally own the equipment but this depends on the terms of the financing agreement.
Leasing terms vary as wildly as lending terms. The costs associated with leasing include:
Equipment leasing loans can make or break a business, depending on the use cases and reasons for doing it. When tech startups know they will need newer, better equipment why would they tie themselves into expenses for servers or other tech equipment which can easily reach more than six-figures per piece of equipment?
Conversely, if a construction business needs a piece of heavy machinery that will likely last one or two decades, why lease it for the next two decades and pay more for it? When debating between equipment leasing and financing, it makes sense to finance it and own it in five to ten years.
For company trucks and cars, the value of the lease payments may be tax-deductible. Other forms of equipment may be similarly tax-deductible, based on their usage split between business and personal use. There are fewer overall tax incentives for equipment leasing. But, the other benefits include consistently being up to date with technological trends and keeping up with equipment updates.
Circumstances and business needs will largely be responsible for dictating whether you need to consider equipment financing and leasing. Even if you could buy it outright, it may not be the best idea due to cash flow restrictions. Consider your medium and long-term goals when looking at leasing vs. purchasing equipment, or other methods of acquisition.