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This often comes down to a tug of war between the lower cash required to get the asset in the building and the long-term higher cost associated with the lease.  If you qualify for a traditional bank loan, you will likely need to have 20% of the asset cost available at the time of purchase.  The cash required at the time of lease is often below 10%, and can be zero with some manufacturer’s captive leasing companies.  In many cases, the all-in costs over the life of an asset can be as much as 10% more with a lease. 

So, here are some great advantages of leasing:

1.       Technology and short-term assets. An asset that will be utilized for a short period of time and be somewhat difficult to sell as used.  Technology equipment for the office, a laboratory, or production equipment that risk being out of date in two years are prime candidates to lease.  If you purchased this asset and used it for 2 years, you would now be faced with finding a buyer for the used equipment and with financing its replacement.  By leasing, you simply arrange for the owner to pick it up and you are free to select the latest and greatest new asset to replace it.  Best of all you have the cash flow from the old lease to help pay for the new and better item.

2.       Immediate Expense Deduction. Lease payment is usually fully deductable as an operating expense.  There are complex depreciation rules and interest charges that might lag your total cash outlays in the early term of the loan.

3.       Debt Management. The lease obligation does not appear as a liability on your balance sheet, while the loan from the bank does.  A loan will have a negative effect your current ratio and your debt to equity ratio.  Most bankers are more than OK with some level of operating leases for their clients. 

When leasing, you also need to carefully review all the terms in the lease.  There are often terms that award penalties to the leasing company for what they consider excessive wear and tear on the asset.  This can lead to an unexpected bill at the end of the lease, and a lot of time and energy to negotiate a settlement on the wear and tear amount.

There is no doubt that the cash required to get the asset in the building can be much lower than that required for a traditional bank loan.  However, if you are planning to utilize the asset for its entire useful life and you have the cash for the down payment, buying the asset with traditional bank financing will always be the less expensive route to go. 

 

Posted by Fred Pieplow
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