Whether home-based, online or traditional brick-and-mortar establishments, all small businesses have at least one concern in common: lease or buy equipment?

As credit dries up in today’s economic environment, companies — particularly small businesses — are finding it more difficult to invest in new equipment to stabilize or grow their organization.

“Credit policies and procedures have and will continue to be tested as will the integrity of business models,” Kenneth R. Collins, Jr., chairman and CEO of Susquehanna Commercial Finance, Inc., recently told the Equipment Leasing and Financing Association. “We expect credit quality to continue to deteriorate through the second quarter of 2009 and that a number of weaker segments such as transportation, construction and some small businesses that have been surviving on dwindling cash reserves, could be culled by this recession.

“This perception could also lead to declines in overall new business as qualified financing candidates considering capital investments remain sidelined by uncertainty that the economy will stabilize or improve any time soon,” Collins continued.

Small businesses range from home-based, online and traditional brick-and-mortar establishments, yet they all have at least one predicament in common: lease or buy?

“The starting point for your decision-making is [...] the projected cash flow statement you’ve worked up showing the dollar benefits of the project, and the costs under the options you’re considering (in this case, leasing vs. purchasing),” online small-business resource Winmark Business Solutions states. “Then, evaluating whether it’s better to lease or to buy can be easily done by performing a net present value (NPV) analysis of your cash flows under both alternatives, and comparing the results you get. The alternative with the lower NPV will be the cheaper alternative in the long run.”

Of course, factors other than cost should also be examined when determining how a small business invests in equipment.

“Deciding whether to buy or lease equipment requires that you understand some base characteristics and how they affect cash flow and asset management,” Tim Lemmons, a University of Nebraska-Lincoln (UNL) Extension educator, recently said.

Both have advantages and disadvantages.

Among the advantages of leasing equipment:

• Lower up-front down-payment costs compared to purchasing;
• Payments often are less than traditional loan payments;
• Less liability on the balance sheet;
• Equipment available for short-term needs;
• Access to and use of the latest technology; and
• For tax purposes, lease payments are considered production expenses.

Among the advantages of buying equipment:

• Easier to replace or sell at the owner’s discretion compared with replacing leased equipment;
• Owned equipment has asset value and may be used as collateral against other loans;
• No security deposit requirements (though down payments to secure financing may be higher);
• No use limitations (Some leases specify the number of machine-use hours before a penalty); and
• Increased asset value on the balance sheet.

“One of the major disadvantages of leasing equipment is that because you are not purchasing it, it cannot be considered an asset and cannot be sold,” Crystal Riley, president of Lease with Crystal, said in a statement last year. “Conversely, after you purchase equipment, it’s yours. This is especially advantageous when dealing with a piece of equipment that has a long, useful — and I emphasize useful — life and is not in danger of becoming technologically obsolete in a short period of time.”

When weighing the economics of buying versus leasing, it is important to understand the key components of machinery value and the change in value over time.

“The most difficult to evaluate is depreciative cost of equipment over time,” Lemmons says.

“Depreciation is defined as the decline in asset value over time,” the UNL Extension educator continues. “It also represents the basic ownership costs of a capital asset and the consumption of an asset’s value over its useful life.”

Riley warns of the same danger:

A computer system depreciates far faster than office furniture. So, you have to pay special attention to the equipment and make sure that what you spend for it today will not be markedly different than what you can sell it for tomorrow. Certainly, some depreciation will occur simply through normal aging and wear and tear, but it’s always something to consider.

“As equipment ages, the accumulated cost of repairs begins to mount,” according to Lemmons, who advises considering long-term repair costs when deciding whether to buy or lease equipment, particularly machinery.

“Repair costs should positively correlate with the total hours of equipment operation; the greater the accumulated hours of operation, the greater the accumulated cost of repairs,” Lemmons says. “Usually the lessee is responsible for all repairs not covered by warranty, just as the owner would be. However, leased equipment may be replaced before repair costs begin to mount.”

Finally, both leasing and owning property provide tax advantages to small business owners. As such, before making a decision on leasing versus buying equipment, small business owners should understand how each might affect their cash flow and tax situation, which will vary from operation to operation.

Most businesses need new equipment at some point, but the Economic Stimulus Act of 2008 made buying more equipment immediately a smart business decision. Section 179 of the Internal Revenue Service tax code now allows businesses to write off the full purchase price of qualifying equipment purchased or financed during the tax year. That means that if a small business buys or leases a piece of qualifying equipment, it can deduct the full purchase price from the business’ gross income. Small business owners should consult their tax professional to ascertain their current tax position.

Section 179 can change yearly without notice, but the current deduction limit is $250,000 and the total amount of equipment purchased cannot exceed $800,000. The American Recovery and Reinvestment Act of 2009, signed into law last month, has extended the enhanced Section 179 incentives through Dec. 31, 2009.

Business owners must carefully consider and weigh the advantages and disadvantages of the lease and purchase options when buying equipment. They must account for individual and operational cash flow and tax needs, the user’s aptitude and skills with the equipment, and the goals and objectives of the business.

Earlier

Lease or Buy in 2008?

New Equipment Tax Incentive Ends in 29 Days

Resources

Leasing Vs Buying Ag Machinery: Factors to Assess
by Tim Lemmons
Univ. of Nebraska-Lincoln Extension, Institute of Agriculture and Natural Resources, Jan. 12, 2009

Leasing Vs Buying Ag Machinery: Weighing the Economics
by Tim Lemmons
UNL Extension, Institute of Agriculture and Natural Resources, Jan. 12, 2009

Several Factors to Assess When Deciding Whether to Lease, Buy Ag Machinery
UNL Extension, Institute of Agriculture and Natural Resources, Feb. 4, 2009

To Buy or To Lease Equipment – That is the Question for Small Business Owners
LeaseWithCrystal.com, April 29, 2008

Should You Buy or Lease?
Winmark Business Solutions

Monthly Leasing and Finance Index: January 2009
Equipment Leasing and Finance Association

Buy or Lease to Equip Your Business?
Goodman Jones, Jan. 5, 2009

When to Lease Versus Buy Equipment for Your Small Business
BusinessKnowlegeSource.com

Lift Truck Tips: Lease or Buy?
by Tom Andel
Modern Materials Handling, Oct. 1, 2008

Economic Stimulus Act of 2008

American Recovery and Reinvestment Act of 2009

Section 179 Qualifying Property
Section179.org