BusinessTN

For a small business with limited startup capital, it can often prove too costly to purchase all the equipment needed to operate. Credit can range from low to nonexistent and loans for large purchases difficult to come by. Financing, while certainly an option, has its own pitfalls. Fortunately, a company doesn't need to own all its assets, and leasing is an oft-used alternative to buying equipment outright. It's all a question of cash flow and flexibility.

There are choices when it comes to leasing options. The lessee can decide between an operating lease agreement or a capitalized lease. An operating lease is set for a limited time, during which the lessee pays installments. Once the allotted time runs out, the agreement is over, and the equipment is theoretically returned. It's a simple setup that does not appear on a company's books, so the value of the company's assets does not increase, but neither does its obvious liability on the balance sheet.

What if the company wants to keep a piece of leased equipment after the lease ends? It's a common practice for the company lending the equipment to count the payments made during the leasing agreement against the price of the equipment, giving the client's business a break on the price once it can afford it. If this is part of the agreement up front, the lease falls under the classification of capitalized lease. Capitalized leases are treated on the books just like an owned asset. All the liability of payments and the possession of the equipment show up on the balance sheet, with the benefits and detriments those entail. If a company is not ready to show the liability, it should avoid classification as a capitalized lease.

Jerry Morton at Crowe Chizek explains that a company should ask four questions when leasing equipment. First, does the title pass to the lessee at the end of the lease term? If it's part of the agreement that your company will own the equipment after paying the monthly rates, you've essentially bought it. Second, does the lease term take up roughly 75% of the equipment's useful life? If the item leased isn't expected to survive past the lease term, or at least not long past it, it's not considered something the lessor can realistically take back. Third, do the total present-day payments equal around 90% of the item's current price? Whether the title of the equipment passes on to the lessee or not, you're still paying almost the full price for it as if buying it. Finally, if the lending company sells the equipment at a token price, such as a dollar, after the lease term is up, it's ostensibly a purchase.

To get around this, a company can let the lease agreement run out with the understanding that it will receive a discount on a later purchase, whenever that might be. It's important to remember that the loaning company wants to sell the equipment; they don't want it back depreciated in value if they can get rid of it. Some equipment, however, will actually rise in value over time. Construction equipment is known to increase in value rather than depreciate, so a company planning to buy a bulldozer, say, after a three-month lease might end up paying more than had they simply bought it outright. Generally, leasing is an option most suited to the startup business, as it frees up funds that can go into payroll and growth. Spreading the cost of equipment out over a longer period of time reduces the risk of the investment and provides a valuable asset that can be used to complete important early jobs. Once the company reaches a level of maturity, the option yields diminishing returns, as it becomes more effective to enter into capitalized leases or use some earned credit to make outright purchases.

It's important to consider how long the equipment will be needed and how useful it will be when the lease ends. (Computers and office technology become obsolete quickly, rarely outlasting the lease agreement.) Figure out the value trend of the equipment before making any long-term decisions. Leases might be more flexible and easier to obtain, but they are often more expensive in the long term than buying the assets, so think about where you want your company to be a quarter, a year or a decade down the road. Leases are a short-term solution to long-term problems, so always keep an eye toward the purpose.