The Cash, The Loan and The Lease: Equipment Loan vs. Equipment Lease

The Cash, The Loan and The Lease: Equipment Loan vs. Equipment Lease

What is the difference between an Equipment Loan and an Equipment Lease? After you have finally found the Equipment you need for your business, now you must now decide between the options available to purchase your Equipment. When purchasing Equipment, you have a few choices: you can pay cash, borrow the money from your bank, get an Equipment Loan or get an Equipment Lease. Here is a quick review of each with its pros and cons.

The Cash: If you pay cash you don’t have to worry about a monthly payment, you own the Equipment and you don’t have to deal with a broker or lender bothering you or trying to sell you some weird residual option. Seems like the easiest option right? Even a half brained nitwit knows “cash flow is king!” so let me break it down for you. When you purchase Equipment with cash, you are utilizing your cash flow to buy a depreciating asset. Unless you are buying an antique, collectible or a rare classic car, all Trucks and Equipment depreciate over time so why put cash into something that doesn’t hold its value? At least money sitting stagnant in a savings account earns you a few percent a year. More importantly, when you have sufficient cash flow it allows your business to operate smoothly or keep up with growing pains allowing you to capitalize the maximum ROI (return on investment). Cash is simply used better elsewhere than in your Equipment, plain and simple.

The Loan: There are a few different loan options when looking to purchase Equipment. You have your Line of Credit or Operating Line, which is a revolving line of credit, usually at a low interest rate that you can use and pay off like you would a credit card. Traditional Bank Financing, which is typically a term loan with your bank and then you have Non-Traditional or Non-Bank Financing.

Operating Lines & Traditional Bank Loans: The biggest and only advantage of borrowing money from your bank, or using your Operating Lines to purchase your Equipment, is that it is often the least expensive way to Finance your Equipment, or so you think. That being said, being cheap is its only advantage and the definition of cheap explains just that. First the obvious disadvantage is that you are utilizing your Operating Capital or Revolving Line Of Credit that you should be using for operating expenses on day to day basis to purchase a Long Term Depreciating Asset. Cash flow is king remember? So what happens when your Operating Capital gets low and you need to borrow some cash from your bank, or from your Operating Lines, but instead you used your 6% money to buy that new excavator you wanted because 12% was too high of an interest rate? You can just borrow more money from your bank, right? Wrong! Banks have an exposure limit and once that limit is hit, you won’t be getting any more money until your revenue increases and you pay off the debt you currently have. Keep in mind that your 6% is not a fixed rate and will go up and down based on the market or if you violate any of the covenants that have been set forth upon you. Don’t be fooled by rate. Just because the rate is low doesn’t mean that it is your best option to purchase your Equipment with.

Traditional Bank Loans also come with a great deal of paperwork, slow turnaround times and low approval rates, not to mention they impose restrictive loan covenants on you, your business and everything in-between. These covenants will limit your ability to borrow future funds and restrict you to maintain certain financial ratios. In the event you violate one or more of these covenants, the lender has the right to demand payment in full of the outstanding loan amount, even though the loan payments have been made on time. What did you expect with something so cheap?

The Equipment Loan: Non-Bank Equipment Loan. When it comes to a Non-Bank Equipment Loan, they are easier to qualify for with a lot less paperwork and headache. These loans are significantly faster than working with your bank and give you additional resources to acquire revenue generating Equipment to help grow your business without limiting or restricting you. This equipment loan has fixed rates with no balloon payments or residual due at the end of the term and rarely have prepayment penalties. However, most equipment loans are not 100% financing, which I mentioned in my last article, and will require you to put a down payment which is typically between 10-30%.

The Lease: Equipment Leasing Equipment Leasing provides the most flexibility when purchasing Equipment and can also prove to be the most cost effective. Whereas Non-Bank financing may require a 10-30% down payment, Equipment Leasing allows you to finance 100% of the asset with generally only one or two payments upfront. Depending on the lease structure at the end of the lease term the customer can either purchase, return, or continue to lease the equipment. These different structures dictate the ownership of the asset in which regulate different tax and accounting stipulations as they are applied to the Lessor or to the Lessee through FASB and Section 179.

Capital Lease: A Capital Lease is a good option if you plan on owning the Equipment at the end of the lease. A Capital Lease is a fixed term, non-cancelable lease with a fixed residual or $1.00 buyout at the end of the term. This structure allows the Lessee to assume some of the risks of ownership and it is recognized both as an asset and as a liability on the balance sheet. With this structure, the Lessee can also take a Section 179 deduction in addition to interest expense.

Operating Lease: An Operating Lease proves to be a good option if your plan is to trade in the Equipment every few years or if the asset is expected to become obsolete before the entire value can be depreciated off the books. As I explained in my last article, the benefits of an Operating Lease would be that you would be able to write off the entire monthly payment as opposed to just the interest expense like a loan or Capital Lease. In an Operating Lease, the Lessor (or owner) transfers only the right to use the property or asset to the Lessee. At the end of the lease period, the Lessee has the option to purchase the property or asset or return the property or asset to the Lessor. Since the Lessee does not assume the risk of ownership, the lease expense is treated as an operating expense on the income statement and the lease does not affect the balance sheet.

Note that we are not tax advisors. For an expert in tax consulting, please advise one of our tax experts, Dean Ferraro with Authoritax.

We understand each company operates differently and in retrospect we understand that one structure might benefit one company more than the other which is why we provide several financial products to our customers. Remember, before you purchase your Equipment, get an equipment loan or lease your Equipment, consider the long-term benefits of each structure and whether the estimated life for the use of the Equipment correlates to the IRS guidelines. With this in mind, we feel you will find the financial product that is right for you every time.

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