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If your business uses vehicles, machinery, or just about any other kind of equipment, you may be considering equipment leasing as a way to cut costs. Equipment leasing can be a solid way to supply employees with what they need to get the job done, but it may not be the best fit. Looking at the larger financial picture, you may be able to find better, more cost-effective methods of obtaining the equipment you need.
Before you sign an agreement, it’s important to be aware of pros and cons. Here’s everything you need to know about equipment leasing and its alternatives.
Equipment leasing is a type of financing that helps small business owners rent equipment, such as heavy machinery or vehicles. Leases come with a set time duration. Once the lease is up, you’ll have to return it, buy it, or renew your lease.
Equipment leasing is different from equipment financing—which involves taking out a loan to purchase the equipment, using it as collateral, and paying off the loan over a fixed term. Once the agreement is paid off, you own the equipment.
Equipment leasing comes with lower monthly payments, but is also more expensive in the long run than financing. At the end of the term, you’ll have to return the equipment, instead of having the option to keep or sell it.
Equipment leasing is more like a rental agreement than a business loan or equipment financing solution.
When you lease equipment, you enter into an agreement with a financing company or vendor. The details of how long you’ll be able to use it and how much you’ll pay each month will be outlined in the contract.
It’s important to keep in mind that an equipment lease is temporary. Once that period ends, you’ll have to decide whether you want to buy the equipment, renew the agreement, or find another vendor.
Equipment financing works in a different way. With this financing option, you’ll obtain a loan to purchase a piece of equipment, which you then pay off over time. Essentially, you’re paying to own an asset, which you can then use as collateral, continue using, sell, or more.
There’s more than one type of lease. Before signing an agreement, be sure to ask questions and learn about various options.
The type of lease you choose could have implications when it comes to accounting and bookkeeping. Different companies may offer various products, but these are the most common types of equipment leasing arrangements.
An operating lease, or fair market value lease, entails renting the machinery or hardware. You won’t receive any benefits of ownership throughout the duration of your lease. However, once it ends, you’ll have the option to return the equipment or buy it at its fair market value.
Capital leases are a good option if you intend to buy the equipment at the end of the lease period. Usually, monthly payments are higher and closer to an equipment loan.
A capital lease may also be called a $1 buyout lease.
You know your business needs new equipment, but you’re not sure if leasing is the right way to get it. How can you make the right decision? This pros and cons list will help you understand if it’s the right move for you, or if an alternative like equipment financing might be the better way to go.
Even though equipment leasing is more expensive in the long run, the monthly payments are lower. It may be a good option for small businesses struggling with cash flow.
Most likely, you will not have to come up with a down payment or collateral to secure an equipment lease. That being said, there are many equipment financing programs that also don’t require down payments.
However, leasing companies will take other factors into consideration, such as your credit score and balance sheets.
Short-term leases allow you to trade out a piece of equipment for an upgraded one. If working with the latest hardware is important for your business, then getting an equipment lease might make sense.
Through equipment financing, though, you’ll also have the option to sell equipment once you own it, then upgrade to the latest model.
With equipment leasing, interest rates are automatically incorporated into monthly payments. Your interest rate is also fixed, giving you a clearer understanding of your future expenses.
You may be able to fully deduct the cost of a newly purchased asset in the first year. You can also qualify for depreciation deductions on purchased machinery.
While monthly payments on an equipment lease are lower, the total cost always ends up being greater than if you were to finance the equipment. After all, you’re paying toward ultimately owning the equipment.
If you’re looking to save money in the long run, equipment financing might be a better option.
At the end of your lease, you’ll need to make other arrangements if you still need to use the machinery. You’ll have to decide between renewing your lease, buying the equipment, or looking into other equipment leasing companies.
Equipment lease agreements come with rigid rules. You may face penalties if you try to get out of your lease before the end date—or you may be unable to cancel it altogether. It’s not uncommon for businesses to have to keep making payments on their lease, even if they’re no longer using the equipment.
The agreements may also detail specific upgrades you are required to pay for or specify how you can and can’t use the machinery.
With equipment loans, your payments go towards owning the hardware. Once the loan is paid off in full, you could sell the equipment, exchange it, or do just about anything else.
Having an asset on your balance sheets also brings additional perks when it comes to obtaining financing in the future. Unfortunately, you won’t gain any of these benefits when you lease.
If you’re torn between whether you should go the route of equipment financing vs. leasing, ask yourself the following questions.
If you answered yes to these questions, then it may be a good choice. Equipment leasing makes sense for businesses with limited working capital or those need to upgrade their machinery every few years.
On the other hand, equipment financing is a solid choice for more established businesses that have enough working capital to cover slightly higher payments, and prefer to save money over the long haul. Businesses operating in industries where equipment maintains a long lifespan would also be better off going the financing route.
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