It seems like every few weeks I get ask the question: Should I lease or buy a new piece of equipment? Unfortunately, it’s not a question that has a simple answer. In fact, the question doesn’t have just one answer. Whether to lease or purchase equipment for your business depends on a number of factors and every situation should be evaluated separately.

First, let’s look at the fundamental differences between leasing and purchasing. Either way, the basic aim is to obtain equipment for use in your business. Here are some basic characteristics of lease and purchase transactions.

An Operating Lease – Generally a short-term arrangement, an operating lease is often referred to as a rental agreement. The term of the lease is significantly less than the useful life of the asset, and the user anticipates that he will turn in the equipment at the end of the term. In most cases the lessee does not have to carry insurance on the equipment, but may be responsible for maintenance. Typically, the lessee will have the option to cancel the lease before the term is completed.

A Financing Lease – In most cases, the term of a financing lease will be substantially equal to the estimated useful economic life of the equipment and the lessee must provide insurance and maintenance during the term. Typically, a lessee will have the option to purchase the equipment at the conclusion of the lease term.

A Purchase – In a purchase transaction, title transfers immediately upon purchase and the risk of loss (insurance) and maintenance rest solely with the buyer.

Most often, when a company is acquiring an asset to be used in the production of its products or services, they will be choosing between a financing lease and a purchase. (I have only very rarely seen an operating lease used to acquire production assets.)

Key Considerations in Choosing

There are several factors that you will want to consider in deciding between leasing or purchasing that important piece of equipment.

Cost – In most cases, leasing is going to cost more in the long-run than purchasing. Leasing companies don’t usually state what the effective interest rate is, but you can figure it out from the payment schedule and the cost of the equipment. Generally, the effective interest rate is going to be higher than your borrowing rate from your bank.

Resources – Unless you have a lot of excess cash lying around, you are going to need to finance the acquisition of the equipment. Leasing may allow you to finance the purchase without using up any of your existing line of credit or other bank credit. Also, credit approval for a lease may be considerably easier than bank approval. Be sure to check your existing bank covenants, though, as many loan agreements have restrictions on leases. (more…)