If you lease a piece of equipment, you don’t own it. However, you do control it and have use of it. Many large companies like airlines and banks don’t own their most visible assets such as aircraft and office towers, they lease them. Their logos get fixed to the structures but these operators know they have better places to put cash rather than in depreciating assets.
All fixed assets depreciate. The tax folks know this and extend a specified rate of depreciation that can be used as an expense. However while its nice to get a little cash back from the tax department it takes quite while before that type of sugar shows up in your bank account.
The only asset that does not depreciate (much) is cash unless you live in a country with high inflation. So the more cash you earn and hang onto the better. Being in business means there are always bills to pay, better to have lots of cash for expenses than too little.
The number one reason why leasing is popular is cashflow. The first job of any firm large or small is to generate cash before any thing else. Leasing allows you to hang onto more cash...today. This is Cardinal rule # 1.
However, there is another big reason and this is tax. If you are the owner of an S-corp with 30 or more employees, its very likely that your tax rate on profit is nudging the 39% rate. This, means that at this rate, a profit of $1000 earns the tax department about $390. There are two sets of financial statements important to business owners and self employed folks: The profit & loss statement and the balance sheet. Plus there is the bank statement. Profit of $1000 looks great on the P&L but looks dismal on the bank statement because the net cash from that profit is $610 in cash terms.
Now here is where this gets real ugly: If you buy a new computer for $1000 with cash, the tax department regards the $1000 (you mistakenly regard it as an expense, right now) as profit, so they want their $390. So you really have to earn a profit of $1390 (over simplified) so the tax folks get theirs ($390) and the computer vendor gets theirs ($1,000). Your cash in bank is DOWN $1390 and now you own a highly depreciating asset in market terms and have full use of the device as long as you wish.
But wait a minute, wouldn’t it make more sense to LEASE the computer and have full use of it and hold more cash in your bank? Yes, and this is the value of leasing.
Let’s hit the reset button and do the math for leasing. That $1,000 computer will cost you $25 monthly (or less) for a term of 60 months. Plus you don’t owe the tax folks $390 because they regard the lease as a legitimate business expense and allow you to deduct $25 monthly. Very nice! You got a little sugar early.
While it is true you will spend a little more by using leasing the comfort of cash is worth more than you know. Many business owners have told us they have woken up in the wee hours wondering how they will make payroll by Friday morning. Never forget Cardinal rule # 1.
But just in case leasing sounds too good to be true, Here is a list of “Yeah buts...” You be the judge.
1) Isn’t it difficult to get a leasing agreement? Not really. They usually respond within 48 hours with a submitted fully detailed application.
2) Won’t I spend more with leasing? Yes but you will also retain cash. Cardinal rule # 1.
3) Leasing companies charge more interest than my bank who will loan me money at a lower rate. True. But all loans are paid back with after tax money so leasing allows you to skate by the $390 the tax guys were looking for in a purchase.
4) If I don’t own it, won’t the leasing firm want the item back? Most of the time...no. They will bend over backwards to figure out a way for you to own the item at the end of the term. Who wants a used laptop returned 60 months later?
5) Is leasing for everyone? No. Sometimes it makes more sense to use a loan and buy an APPRECIATING asset such as real estate especially if you are in the rental business.
One last comment about leasing and a short description of perhaps the most creative form of leasing ever devised: Rolls Royce decided to stop selling jet engines. They manufacture them, but refuse to sell them. Instead, the airlines and defence departments of the world pay Rolls Royce dollars per RPM. This means the leasing companies that buy the aircraft buy them without engines! The CFO’s of the airlines only have to pay per RPM!
Cue the video of The Count from Sesame street laughing his face off, counting all the cash. Cardinal rule # 1.