While it may be simpler to pay cash or take out loans on your vehicles and equipment, loans might not always be the best choice for the strategic needs of your company. To find out more about the different financial impacts of leases and loans we talked to two experts from LeasePlan USA: Bryan Steele, national vice president, client relations; and John Shevlin, director of taxation. Here’s what you need to consider to make the best decision.
With a loan you pay a fixed amount every month for a period of typically three to five years until the asset is paid for completely and you own it outright. With a lease you also make monthly payments but the amount is usually less than that of a loan payment because the asset will often have some value accruing to the leasor at the end of the term. The difference between the loan payment and a lease payment then becomes free cash that you can use in other areas of your business.
The question you need to ask yourself is what do you want to do with the money you’re earning in the business, Steele says. “You may be better off leasing the asset in order to use the money in a different part of your business than through a loan. You need to determine how you want to use that capital, whether it’s hiring more employees, building a warehouse or expanding the business.” This is particularly important if one of your goals is to grow the size of the business or grow your market share.
The difference between a monthly loan payment and a lease payment may not seem like much, but if you have a fleet of vehicles or high-dollar machines you’re financing it can add up. “For example, if a customer leases 100 units, and $20,000, that’s a lot of cash tied up in those assets,” Shevlin says. Another consideration is how much money banks or other financial institutions are willing to lend you. “They’re going to put a cap on how much they’ll loan you,” Shevlin says. “You only have so much capacity to get financing and you have to use that to the best of what your goals are.”
Assets that you acquire through loans can be depreciated, leased equipment and vehicles cannot; but you have to carefully calculate the value of the depreciation vs. the declining value of the asset. “The asset may still have market value at the end of the loan,” Steele says. “If you’re going to pay it off in two years then it will be worth a lot more than if you stretch it out over a five- or six-year period.”
Taxes and expenses
You can deduct the interest on your loan payment from your taxes. Lease payments offer no tax relief, but they can be treated as a business expense and deducted from your earnings just as you deduct fuel, material and overhead costs. How this affects your bottom line is something you’ll have to work out with your accountant and tax advisor. But in general you don’t want to make tax avoidance a major part of your business strategy. “If you start using accelerated depreciation to reduce your tax liability, you still may have to pay the alternative minimum tax,” says Shevlin. “The biggest reason companies get caught in the AMT is because of depreciation differences.”
Advantage: depends on what your tax and accounting people say, but don’t strain your company just to pinch pennies with the Internal Revenue Service.
The last payment
With a loan, the end goal is usually ownership of the asset. That’s a reasonable goal if you know you’ll need that asset after the loan is paid off. If the need is temporary or you’re not sure, a lease may be your best option. And while most assets have some residual value at the end of the loan period, the maintenance costs usually go up too, so factor that in. Long-term maintenance costs for equipment can be considerable, vehicles less so.
Advantage: depends on your long-term goals for the asset.
“With a loan you have administrative costs associated with that asset,” Steele says. “These can include license and title expenses, operating costs, repairs, potential accident management, maintenance or driver compliance issues.” Under a lease scenario many of these administrative burdens are taken on by the leasing company. If you want to convert a lease to a loan in a buyback situation you may also get hit with additional costs of re-licensing and titling issues as well as a sales tax, he says. The laws on these issues vary from state to state, so it’s best to do your homework first.
Advantage: depends on state and local regulations.
No financial decision should be made without first consulting your accountant and tax lawyer or advisor. Every company is different and even within the same company at different periods in its history the choice may change as well. Determine your goals first – cash needs, tax status, ownership responsibilities – then put a pencil to both scenarios with your numbers people and examine the full range of issues side by side to make the best choice.