Here's the 12th newsletter in the Business Management series that will take you through aspects of managing (business, financial, jobs, labor) giving you insights and techniques to help you build a better business.

The following content is extracted from Mike Holt's Business Management Skills Workbook.

At some time during the life of your business, you'll find a need to acquire specialized or expensive equipment, and you'll have to make the decision whether to buy, rent, or lease it. That can be influenced by a variety of factors, such as:

• What is the equipment needed for?
• How often is the equipment needed?
• Where is the equipment to be used and stored?
• Is there capital available to support a purchase or lease?
• Does the ROI (return on investment) justify the expenditure?
• What are the tax advantages of each of the three options?

Each of these options has its own justification depending on your type of business, current tax laws, and how you answer those questions.

Renting
If your need for a piece of equipment is only occasional, renting may be your best option so long as this cost is factored into the job. Renting is convenient as the equipment is typically delivered to the job site and the rental source is responsible for maintenance and repairs. One advantage of renting is that rental agencies will often provide a course and sometimes certification on the operation of the rented equipment that satisfies OSHA requirements. Renting equipment is considered an expense on your balance sheet and is deducted from your revenue number when calculating profit for tax purposes. A good rule of thumb is to rent equipment until the cost of rental in a year exceeds the cost of ownership of the identical equipment.

Leasing

• A lessee (the person to whom property is leased) can enjoy the use of an asset without a large initial cash outlay.
• There’s usually a very small down payment if any, whereas a loan usually requires a down payment.
• Payments are not tied to asset ownership so they can be very short-term or spread over a long term depending on the needs of the lessee.
• You have protection against equipment obsolescence since lease equipment is usually returned to the lender at the end of the lease term.
• Tax benefits can include deductibility of lease payments as operating expenses. The lessor usually takes the investment tax credit for the asset, but the lessee can benefit from reduced payments in return. See your accountant before committing to a lease to verify tax effects.
• Payment amounts and schedules are very flexible and can be arranged to match the duration of a project to ensure the expense is covered by the need.

There are restrictions on claims in the event of bankruptcy.

Disadvantages of Leasing

• There is a loss of certain tax benefits to the lessee that go along with ownership of an asset. Again, be sure to check with your tax advisor.
• A leased asset has no tangible economic value at the end of the lease term since it belongs to the lessor.
• There’s higher overall cost for the equipment to be leased versus direct purchase since the lessor has to pay for the cost of the money used to finance the lease.
• Early lease termination can be a cumbersome and expensive process.
  

The lease represents a senior debt obligation. Although in the event of bankruptcy, claims of a lessor to the assets of a firm are more restricted than those of general creditors, a lease may be one of the first debts that can be claimed by a creditor. When it comes to deciding whether to lease or purchase, some follow the general guideline that “if it appreciates, own it—if it depreciates, lease it.”

Purchasing
Buying equipment can be costly and should be given careful consideration before making the purchase. Some of these considerations include:

• Can I afford it? Do you have the capital or cash reserve to cover the expense?
• What are the equipment warranties and for how long?
• Are there performance guarantees and/or service agreements?
• Are you equipped to deal with a break-down or will you endure significant downtime waiting for qualified personnel to deal with the issue?
• What is the equipment resale value? Is there a 'buy-back' option?
• What is the cost of operator training or certification?
• Is there sufficient space available to house the equipment?
• Can you transport the equipment? Is a trailer an additional expense to be considered?
  

These are all valid and important considerations but perhaps the biggest advantage to owning equipment, is that it's always in stock and there when you need it. Once you have invested in a piece of equipment you will find that you will be more competitive for that type of work than a competitor who has to rent or lease because your costs will be lower. You may also find that the equipment can be used to increase productivity on jobs where equipment rental would normally be cost prohibitive.

As with all large business purchases, tax advantage isn't the only consideration to make before you determine if you should rent, lease, or purchase. You must consider if you have the working capital and cash flow to support your decision and a plan to use the equipment to increase your profits. Owning expensive equipment that doesn’t make you money is a bad business model.

We'd love to hear from you about this series, and the ways you're using it. Send us your comments and feedback by clicking on Post a Comment below. Look out for the next part in this series a month from now, and please share with your colleagues.

This content is extracted from Mike Holt's Business Management Skills book. If you have enjoyed this newsletter, you can get the full content here.