Lease financing has been a popular cash flow management strategy in Canada, and later expanded to the US and international markets. It has many benefits and can be used for both property and equipment.
Although most leases, with the notable exception of sale-leaseback arrangements, do not actually generate capital for the companies that enter into them, they nevertheless do offer a variety of financial benefits that enable companies to conserve their precious capital and apply it to other purposes.
The benefits of lease financing are that it:
Protects against obsolescence. Short-term operating leases enable lessees to upgrade to better or more current equipment on a regular basis. The advantage of this kind of arrangement becomes particularly obvious when you consider purchasing technology such as computers. If you buy 100 computers for your business, you probably aren’t going to be eager to replace them when, in two years’ time, they are virtually obsolete. If you lease your computers, however, you can simply turn them in to the lessor at the end of the two-year lease term to be replaced with the latest technology acquired under a new lease.
Increases flexibility. When you purchase equipment, it’s yours, period. Leases enable you to customize the terms of the transaction to meet your needs in such ways as
- The duration of the lease
- The amount of cash you put down
- Provisions for buying out the lease
Not only that, but you have a chance to try out a specific piece of equipment for a limited time instead of committing to buying it and then hoping that it works out for you.
Improves cash flow. Purchasing expensive equipment can put a major dent in your cash flow as the amount of cash that flows out of your business temporarily exceeds the amount of cash that flows in, which often happens when you buy something big. Depending on how quickly the cash is replenished from revenues, the impact can be negative for some time. Many leases require no money down, with payments due monthly. The less cash you put out to acquire the equipment you need to run your business, the better your cash flow. And don’t forget: Happiness is a positive cash flow.
Preserves capital. Because leases often require little or no money down and you make payments on a monthly, pay-as-you-go basis, you can leverage an equal amount of cash to acquire much more capital equipment than you can in an outright purchase. While you might pay $100,000 in cash to purchase four new vehicles for your business, for example, leasing may enable you to acquire not only the four new vehicles, but also a new telephone system, new furniture for the home office, and new computers for all employees.
Treats payments as expenses rather than debts. Accountants consider payments made under certain kinds of leases to be expenses rather than debts, enabling the companies to keep the equipment off of their balance sheets. This approach minimizes the company’s debt and leads to more favorable debt ratios (and a more favorable climate in which to approach banks and other financial institutions for loans and other financing).
Comes with tax advantages. Payments made under short-term operating leases are fully tax deductible, as are many of the costs (if any) of initiating these leases. You write off payments immediately, and fully realized tax savings don’t have to await a five- or seven-year depreciation schedule.
Enables your company to acquire more/better equipment. Because leasing cash often goes much further than purchasing cash, using a lease to acquire equipment may significantly reduce your initial cash outlay. Although you can retain the money you save in the process, you may choose to use the extra cash to acquire even better (and more expensive) equipment.
Makes getting credit easier. All things being equal, a company generally has a much easier time qualifying to lease a million-dollar piece of equipment than obtaining a commercial loan to buy it. For relatively young companies, or companies without an established track record, leases can offer a tremendous financial advantage. Not only that, but many bank loans also have quirky loan covenants. Sometimes leasing is somewhat overlooked in the debt to equity ratios and debt coverage ratio. On the other hand, you will almost certainly have a ceiling on the amount you can borrow.