Lease or Buy?

By: Ruth King

 

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The next time you need computer hardware and software, a copier, or vehicles, you’re likely to ask yourself the question, “Should I lease or buy it?”

 
Some business owners have made the decision that they will have no debt. They buy all their assets for cash. Some business owners finance every asset purchase through a bank. Some look at cash flow, the use of the asset, its usable life, and make a business decision based on that analysis.
 
The real question is, “Where do I want to spend my cash?” If you know that for business operations you need to maintain a minimum balance of $100,000, why would you take 20% to 25% of that amount to buy a truck or computer hardware/software? That could put your cash in a dangerous situation if business suddenly dropped or a customer didn’t pay his bill on time. However, if you have excess cash and your policy is no debt, then you might purchase that asset. If you don’t have excess cash and your policy is no debt, then you might miss a great opportunity to purchase that asset at a bargain price.
 
Say you have a great relationship with your banker and you finance everything through the bank. Since the bank doesn’t own the asset, they may have restrictive covenants which could impact your ability to do business. There may be a limit to your line of credit and total loans that you reach in slower times of the year. I’ve also known banks to require that a company earn a profit each year to maintain a line of credit. With that covenant, the bank could call in the line of credit the first time the company did not earn a profit. Imagine having a bad year and getting your line of credit pulled at the same time.
 
The major difference between a bank and a leasing company is that the leasing company owns the asset. You have use of the asset. If you’re smart, you’ll use the asset to generate revenue and cash. For example, if you have a truck lease payment of $500 per month, does that truck generate enough revenue and cash to pay for that lease? Assuming that your leased service truck generates a minimum of $150,000 per year, at a net operating profit of 1% the truck generates $1,500. Even with that miniscule net operating profit the lease still pays for itself.
 
Most companies I know don’t own their copiers. They have a lease which covers the use of the copier, maintenance, and repairs. Whenever the copier breaks down, they make a telephone call and someone comes to repair it. At the end of the useful life of the copier, they get another one. They don’t even think twice about it.
 
What if you are leasing your computer hardware/software? Will that lease improve productivity and efficiency to cover the lease payments? If your financials have been a mess and the new software allows you to have accurate financial statements or the software enables you to operate more effectively, then the software lease should pay for itself.
 
There is no one correct answer to lease vs. buy. Since cash is the life blood of all businesses, look at leasing vs. financing vs. buying outright from a cash position. If you have excess cash you might make one decision. If your line of credit is used for business operations and an asset purchase might put you over your credit limit, you might make a different decision. A third decision might be when you want to maximize the use of the asset and your cash position. Then, you would lease the asset, ensure that you are generating enough revenues and cash from its use, and let a reputable leasing company deal with the asset management headaches.
 
Published: November 19, 2013
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Ruth King

Ruth King is a serial entrepreneur, having owned seven businesses in the past 30 years. Ruth has been instrumental in helping business owners understand and profitably use the information generated from the financial segment of their businesses. Recently, she was the instructor for ICE, the Inner City Entrepreneur program in conjunction with the Small Business Administration. Ruth has written many manuals and books, and she was the 2006 USA Best Books Winner for Entrepreneurship and a finalist for the Independent Publisher Awards (IPPY) for her first book, “The Ugly Truth About Small Business.” Her best-selling book “The Courage to be Profitable” was published in 2013.

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