Leasing or buying assets – the pros and cons
In a nutshell, the answer depends on how each purchase impacts your working capital and if you can afford the drop in cash reserves.
For example, if an asset costs $300,000, you could lease it, buy it, finance it, or a combination. You're less likely to buy it if the purchase soaks up all your cash reserves (which you rely on for working capital or other growth opportunities). You may choose to lease or finance the purchase instead to preserve this capital.
Of course, the reverse is also true. If you have $3m in cash and the business is making a healthy profit, it may be best to buy the asset.
Other reasons to buy
Usually long term, it's cheaper to buy an asset than lease it as you can claim the depreciation over time, and in some cases (such as buildings and land), the asset can appreciate.
Buy if it makes financial sense and:
- The asset is integral to your overall business success, and you will use it regularly.
- You want control over the asset as it is mission-critical to your business. If access is denied, your business is over.
- It's easy to update, upgrade, or you can scale up if demand increases.
- There is a healthy second-hand market if you eventually want to sell it.
- The supplier has great support, and maintenance is easy for you to do, or they have a program to help with repairs and replacements.
- If it's an option, you can source the piece of equipment second-hand, so it's more affordable.
Decide to lease
When you lease an asset, you're renting it for a set period of time. The leasing company retains ownership of the asset while your business has the exclusive use of it for the term of the lease.
Lease if it makes financial sense and:
- The asset could become obsolete fast, and you don't want to pay for upgrading.
- You don't want to spend your cash reserve or go into debt.
- The asset needs specialist support, and you don't want to employ a full-time person to manage or pay for this overhead.
- You're unsure how long you'll need the asset and prefer to lease over a shorter time until it's proven.
- You're unsure of current market demand and may need to upgrade (or downgrade) in the near future. You don't want to be stuck with an asset that is either too small/fast or too big/slow.
- You want to maintain a cash buffer to invest in more stock, develop a new product or service, or just use as spare working capital to keep the business ticking.
A lease will typically run for anything between 12 and 60 months. Once the agreement is entered into, both parties are obligated to see out the term of the lease.
Throughout the course of the lease agreement, you'll pay the supplier regular installment payments for the right to use that asset. Most leases are classified as expenses for accounting and bookkeeping purposes and can be claimed directly against your profit and loss.
Borrowing to buy
A hybrid option is to finance the asset with a bank loan. You get the benefits of both; you own the asset, have monthly repayments, and preserve your cash reserve.
Important questions to consider
Before deciding whether to buy or lease, it's prudent to take a few important factors into account, such as:
- How long will you need the asset? Is it for a short-term project?
- Is it cost-effective? Will the extra business you make cover the expense of leasing or purchasing?
- Will the asset become outdated in the near future? For example, signing a five-year lease on a computer that will become obsolete in three years doesn't make much sense.
- What are your current financial priorities? Are there other purchases that should be made first?
Consider upgrades and maintenance costs
There are usually options where the lease agreement can include upgrading the asset to a newer model once the agreement expires.
Likewise, some lease agreements may also include maintenance and servicing costs. By leasing some assets, you could avoid paying any upkeep costs associated with them, saving your business money over the long term.
It's important to look closely at any lease agreement before you sign it. You may find that some agreements:
- Allow you to purchase the asset at a reduced cost when the lease expires.
- Allow you to exchange the asset and upgrade to a newer model when the lease expires as long as you enter into a new agreement at the same time.
Always be sure you understand an agreement's terms before you sign it.
Run a cost comparison and a cash flow analysis between leasing an asset and buying. Discuss with your accountant the potential impact leasing or purchasing may have on your cash flow and ask what alternative options might be available.
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