For the last ten years, rental and operating lease have been a popular and effective way to finance the purchase of new equipment. In this article, I am going to highlight some of the advantages and disadvantages of entering into this type of financing facility.
Probably the key benefit of renting is that the monthly repayments are usually lower than with a secured loan or finance lease assuming the lessor has taken an undisclosed residual position. Having said that in today’s tight credit market, this benefit is becoming somewhat marginalized.
Most commonly touted benefits:
1. The business will get the benefit of the asset without an expensive upfront outlay of cash
2. The debt is secured against the asset and does not reduce existing lines of credit
3. The equipment can be upgraded within the term of the lease
4. Generally, lease rental payments are fully tax deductible. However you should seek independent taxation advice, as this may not be applicable to your situation
5. Equipment can be replaced at the end of the lease term with the latest technology without the cost of disposal of existing equipment
6. In many cases, there are balance sheet implications of an operating lease or rental agreement whereby the lessee does not have to disclose the liability of future payments
No doubt, the key disadvantages of operating lease or rental are in the terms and conditions which vary quite a bit from lessor to lessor:
1. Rollover payment which are additional payments contracted under the lease if the lessee fails to meet various administrative requirements
2. Inertia payments or rent paid after the initial contractual term has expired often without the lessee realizing
3. Excess use charges are incurred when the Lessee exceeds the a contracted number of hours or pages utilized by an asset on a lease this can increase the cost of ownership by as much as 20% to 30%
4. Onerous return conditions such as wear and tear charges and costs to return equipment to interstate locations can add unexpected costs
5. An early termination of a lease often has hidden penalties that exceed the discounted sum of the remaining payments
When considering to lease or rent, the most important consideration is the issue of ownership. When renting, the lessor always retains ownership. So if at some time in the future you wish to own the asset, you will have to purchase it from the lessor at a value acceptable to them. In some cases, this may be the best way to go particularly if at the end of the fixed term you are confident you will no longer have a need for the asset or will benefit from an upgrade. Below are some things to consider prior to making this decision:
1. The operational life of the asset
2. Impacts of technology changes on the asset
3. Volatility of the future value of the asset
4. How critical the asset is to the day to day operation of the business
5. Ease at which the asset can be upgraded or replaced
I think it is important to point out that there is no right or wrong answer to the question as it highly dependent on individual business circumstances. Often the answer is not clear cut, therefore I would recommend at least getting an opinion from your accountant or business advisor before making any decision.