Lease or Purchase? Making the Right Call
by Kevin Clune
Move to integrate U.S. accounting standards with global ones has local impacts, too.
If you’ve been around for a while you’ve probably read more than you’d like about the “lease vs. buy” or the “lease vs. bank loan” analyses. Tomes on the subject sometimes work more effectively than Tylenol PM.
The concept of leasing actually goes back about 4,000 years. Clay tablets have been found in the ancient city of Ur dating to 2010 B.C., detailing the leasing of agricultural tools. At later dates, Egyptians, Greeks, Romans and Phoenicians all engaged in the leasing of ships. In this country, the concept of leasing took root in the 1700s with leasing of teams of horses; it became more widespread in the next century within the rail and maritime industries.
Leasing surged in popularity after World War II as the U.S. economy took off. Quickly-expanding companies sought to acquire the equipment they needed without depleting cash and exhausting bank lines. Tax law changes gave companies the ability to expense certain lease payments, which gave them faster tax write-offs.
Traditionally people have been attracted to leasing because it:
• Is quick and simple.
• Accommodates equipment acquisition to fit with a budget.
• Makes tech upgrades easy.
• Helps leverage capital for growth.
• Preserve credit line with bank.
• May provide tax benefits.
• May not be listed as a liability on the balance sheet.
• Preserves cash.
For many years, the last two bullet points were important motivators, but they are now in a state of flux. The Federal Accounting Standards Board and the International Accounting Standards Board are working on joint projects to make the U.S. Generally Accepted Accounting Principles compatible with our international counterparts. It seems highly likely that this effort will require all leases, even on real estate, to be disclosed on the balance sheets of American companies. Under the status quo, most operating leases for American companies are only disclosed in footnotes.
How might these changes affect the leasing industry? The jury is still out, but some companies have leased equipment to hide debt and make their leverage ratios conform to covenants in loan agreements. Most weren’t so motivated, but many feel that this may diminish demand for leasing for certain companies leasing large-ticket items.
“Preserve cash” has always been a big factor in the propensity to lease discussion but not so much lately. That all changed with the coming of the Great Recession. American businesses have hoarded cash to the point where there is more cash on hand in American businesses today than ever before. This won’t last, but for now, it dampens demand for leasing.
When the CFO or owner makes the lease-vs.-buy analysis, a big factor is all the cash on hand earning very little on deposit. It’s no surprise that record numbers of companies are paying cash rather than leasing/financing. For the first time in my career, our biggest competition is cash, rather than other leasing companies.
All of the other motivators for leasing still exist and indeed are enhanced. Generally speaking, banks are still unlikely to want to finance 100 percent of an equipment acquisition. Most U.S. companies have had their lines of credit reduced and/or restricted, so it is very important not to tie up one’s line of credit to acquire assets that depreciate quickly.
Bank financing is inherently slower and more deliberate than a lease that can be decided and documented in a matter of minutes. Leasing companies can act as a secondary bank by providing financing for equipment, thereby allowing companies to leverage more effectively to accommodate growth.
Very few kinds of equipment are not vulnerable to obsolescence due to technology changes, so it still behooves many to lease and upgrade regularly rather than purchase and hold on to equipment longer than they’d like. Lease rates are at record lows so it’s a good thing to “lock in” sooner rather than later.
Traditionally about two thirds of all equipment sold in this country is leased or financed in some way. Currently that percentage is down to about half but isn’t likely to stay there for long. When the economy starts breaking out leasing will be an essential means by which businesses can acquire the equipment they need to keep up and not be left in the dust.
Speaking of dust, I’m wondering if clay tablets could make a comeback … they’re very “green,” natural, reusable and recyclable. . . .
Kevin F. Clune is president of Clune & Co., a 55-year-old capital equipment lessor based in Mission, Kan.
P | 913.498.3000
E | kclune@clune.net