Businesses today face a different set of challenges compared to businesses operating a few decades ago. Not only are they facing more competition, but they are operating in tumultuous economic conditions. This has been especially apparent in 2020 with the spread of the global pandemic around the world. COVID-19 has not only crippled millions of companies world-wide but has brought industries to their knees.
Business continuity is extremely tough in this type of economic climate, with business expansion being even trickier for most companies. Equipment is vital for companies to function, however, it is incredibly expensive to acquire, repair, or replace. It can be extremely difficult for companies to get the right equipment to scale their business operations as well as remain ahead of the competition.
Luckily for many businesses globally, equipment financing solutions can be offered to companies to assist with the acquisition of the equipment. Some of the most popular come in the form of leases. These are straightforward ways of acquiring the hard assets you need to continue your business operations. They are also very popular and useful for small businesses and start-ups.
We took a look at leases, and in particular, operating leases, and unpacked why businesses prefer to choose them. So, if you are looking for a financing solution to suit your needs, here are five reasons to choose a lease.
What is an Operating Lease?
An operating lease is a form of financing offered to businesses that allows them to acquire necessary equipment without buying it. The cost of the equipment is rather spread out and paid in monthly installments until the end of the term when the equipment is usually returned to the lessor.
Companies can choose from a number of different leasing options, the two most popular being finance or capital leases, and the other being operating leases. Operating leases differ quite significantly from capital leases, and are usually used when the lessee is not interested in actually owning the equipment.
Essentially, a capital lease will end in the lessee taking over the ownership of the equipment at the end of the term, after paying a residual sum. In an operating lease agreement, however, the lessee will either return or re-lease the equipment from the lessor, depending on what their specific needs are.
Operating leases come with numerous benefits that organizations like to take advantage of. We took a look at why certain companies would opt for this type of lease over a capital lease and how it can work in their favor.
Operating Leases Mitigate Equipment Redundancy
Most operating leases are there for companies to make use of the latest products in equipment and technology but without the price tag. With technology evolving as quickly as it is, equipment can become redundant after only a few months to years, with new, more evolved versions being released.
Businesses don’t really want to keep spending thousands on replacing equipment repeatedly over a number of years and opt for monthly payments on the latest technology.
Let’s take a look at a practical example. Office equipment like printers and laptops is the kind of technology that you would sign an operating lease for. These usually age rapidly, with newer, more advanced versions being released annually or every two years. Lessees can sign for a duration of time that allows them to use the equipment for the greater part of the equipment’s useable lifecycle, and return it once a new and more updated version is released.
This allows the company to remain competitive in the market. By being able to constantly update their equipment, they are able to make use of cutting edge technology in the field and keep their products and services updated. It also reduces the amount of equipment wastage and disposal by businesses. Leases allow equipment to be returned, usually to the manufacturer, and it can be recycled properly.
Operating Leases Are Less Financially Risky
Businesses, especially small businesses, and startups benefit greatly from operating leases due to their low-risk impact on the organization. Without the leasing option, companies would have to delve into their working capital to purchase equipment, which is usually a large lump sum.
Smart financial advisors usually guide businesses away from using working capital to make large purchases. These funds need to be used for day-to-day expenses like wages, rent, and operational costs. Should you dip into these funds, you could be putting your company at risk, especially hitting unexpected financial misfortunes. COVID-19 is a perfect example of this. The pandemic hit unexpecting companies, crippling their income. Companies need to rely on their working capital to be able to float the company during these times, but if you have allocated a large portion of this to equipment, you could find yourself in trouble.
It is, therefore, more advisable to spread the costs of price-heavy equipment over a number of months that take the impact of the full expense at once. This will allow the business to continue to operate and expand while using the vital equipment.
An Operating Lease is All-Encompassing
The third reason why businesses prefer to sign an operating lease is due to the fact that all of the associated costs of equipment will be included in the lease. As an owner of the equipment, you are signing over the responsibility of the equipment solely onto you.
Costs like maintenance, insurance, operating fees and, licenses, and associated travel is something that the owner will need to cover. In the case of an operating lease, the lessor will retain ownership rights of the equipment throughout the term and will be responsible for all costs that come with the equipment. These costs will simply be factored into the monthly lease fee, but it will be up to the lessor to determine these costs at the beginning of the term.
Consider the case given earlier. Should a company be leasing a printer from a lessor, the lessor will be responsible for the regular maintenance and repair of the printer while it is in possession of the lessee. The lessor company will usually have specialist technicians to work on the equipment and will send them to complete the work on the equipment.
In many cases, especially for highly technical equipment, the lessor will need to factor in training the lessee company on how to use the equipment. These costs will be included in the overall monthly leasing fee and continued support and troubleshooting are usually covered during the duration of the lease.
It Makes Financial Sense
Financially, operating leases are great for the books, for future credit, and for future investment. It also has some great tax benefits for the company.
Operating leases allow a company to make use of an asset, without the financial ramifications of it. Because the equipment will never be owned by the company, this will not be conveyed on the balance sheet. In most cases, when owning and using equipment, businesses need to report assets, liabilities, as well as the depreciation of the equipment. This is not the case when using an operating lease.
Much like rent, operating leases are considered expenses on the financial statements and are expensed on the income statement. This, in turn, impacts both the net income as well as the operating income.
This, in turn, will impact how future creditors and investors view the company’s financial position. Due to the fact that the functional equipment is not listed as an asset, this will open up the company to future credit streams and financing due to the low risk of the company. Investors also respond well to leases on the financial statements. It shows that the company can live up to monthly financial obligations as well as continue business operations and expansion.
Lastly, operating leases are great for tax benefits. Because an operating lease is considered tax-deductible as “ordinary and necessary” business expenses, it can be written off to tax.
Because a lease is short term, it is not considered a debt, and because you don’t need to consider the depreciation of a lease, it is 100% tax-deductible. You will also be able to write off the interest of the lease as this is tax-deductible.
In essence, you will be able to get most of your monthly payments back from taxes, so speak to a qualified and experienced tax practitioner to assist you with the process. They will be able to help you structure a deal that provides you with as much kickback as possible.
Operating Leases Are Flexible and Easy to Acquire
Operating leases are notoriously popular among small businesses due to the fact that they are simple, flexible and approval rates are incredibly high.
In most cases, buying equipment for a start-up is not only difficult due to the fact that the costs are so high, but also due to the lack of credit history. Getting approved for an operating lease is a lot easier, and more lessors are open to new business due to the fact that they use the equipment as collateral. Should the lessee default on payments, the lessor will simply take back the equipment into their own possession, impose penalties and end the lease.
Should the business not have a credit score, the lessee will also take the credit score of the owners into consideration, but this is not a frequent practice. Leasing companies prefer to partner with their clients, so should the company be high risk, various fees and potential penalties will be factored into the lease.
Lessees also prefer operating leases due to their flexibility. It is commonplace for the lessee to be able to negotiate some of the terms and conditions of the lease. Whether it be duration, interest rate, associated costs, or even a deposit, lessors are usually eager to help finance the equipment.
Leases are also usually easy to apply for and to be approved. The process is usually incredibly simple and approval takes from a few hours to a few days to process and go through. This means that companies can take delivery of their equipment swiftly and continue working as usual.
In closing, we highly recommend operating leases should you be looking to build and grow your organization, especially if you are operating on a budget. Not only can it work out financially for you, but you can remain competitive, and continue scaling your business, even during a financial downturn. It is advisable to do thorough research on your financing company and shop around to find the one that fits your company’s unique needs.
As mentioned previously, a good financing company will consider you a partner and will spend time getting to know your company, your needs, and your unique financial position. They should be in a position to have an insight into market trends and risks and will be able to advise you against possible pitfalls in leasing. Together with the financing company, and a great tax consultant, you should walk away with a lease agreement that fully benefits your company and helps you grow into the company you want it to be.