Many small business people wonder whether it’s better for them to buy or lease capital equipment for their businesses. Your options regarding leasing or buying depend upon the nature of your particular business, but there are nevertheless a few guidelines you can follow to help you decide what you should do.
If you have the money available, and the item is really necessary to your business, then it will usually benefit you to buy the item outright. If there is no way you can find the finance (i.e., you have no money) then you will have to finance the purchase out of cashflow, which means leasing it.
If the item is only going to be used every now and then, there is no real point in buying one. It will lie around for most of the year unused and is therefore a waste of your resources. So lease or hire the equipment when you require it.
Could you earn a better rate of return on the capital required for the item if you invested it in your business? Your business might be at the stage where a few thousand ploughed back in as working capital will give you a far better rate of return than tying up the money in equipment. For example, would the money be better spent on marketing? In this case, it might pay you to lease.
Let’s take a simple example, and calculate the net profit results for both options. Suppose you decide the business needs a machine worth $2,000 (we’ll ignore GST). You can either buy the machine outright or lease it (rent).
You’ve spent $1,200 in cash, and can claim this $1,200 as a business expense. By having $1,200 as expenses, you’ll pay less tax (as opposed to not having the machine at all) of $288 (assuming a tax rate of 24%). So you could say that you’ve spent $1,200 and ‘saved’ $288, giving a net cash out for the business of $912 for that tax year.
You spend $2,000 in cash, and claim $660 as a depreciation expense, which gives you a tax ‘saving’ of $158 (24% of $660). So your net cash out is $1,842. Therefore, in the first year, it would have been better for the business, as far as cashflow is concerned, to have rented the machine. But what about year two? In Option One you’d still have to pay $1,200 in rent for that second year, and the net cash out is still $912.
But in Option Two, you have no further cash to pay, and can still claim depreciation of $442 (33% of the asset’s now depreciated book value of $1340), which gives you a ‘saving’ of $106.
This comparison shows, therefore, that whilst you might have gained a slightly better cashflow situation in year one, the lease option becomes far less attractive in subsequent years.
So as a rule of thumb, if you lease equipment you will make a cash saving in the first year or two, and this is a viable alternative if you do not have the cash (especially for equipment that may cost thousands of dollars, or items you do not use regularly). However, long term, it’s much better to buy equipment outright, provided you can safely ride out the initial heavy cash commitment.
In this way you avoid being stuck with outdated equipment that has little resale value or no longer serves your needs. This is often very much a judgement call that you can only make after speaking to the salesperson concerned.