Inquire before you sign
May 29, 2003
Equipment leasing—an arrangement in which a business pays for the use of equipment but does not own it—is growing in popularity for many reasons. Benefits of leasing include flexibility, convenience, and protection from having to be responsible for equipment obsolescence.
|A lease finances only the value of the equipment expected to be depleted during the lease term. The lessee usually has options to return the equipment to the lessor, purchase the equipment at fair market value or a nominal fixed price, or renew the lease.|
Approximately eight out of 10 U.S. companies lease equipment. In 2002 an estimated $204 billion out of a total $655 billion new-business equipment investment was for equipment leases.
It is important to point out that leases are not loans. Although the costs of leasing are comparable to those of other financing options if you look at the entire transaction, leasing costs are calculated differently than the costs of loans. A range of leases is available, from short-term operating leases to long-term finance leases.
If you are considering leasing equipment, read the lease documentation carefully, and then answer the following questions before signing on the dotted line.
Knowing how and how much you will use the equipment are important for determining the appropriate level of investment. By comparing the periodic leasing payment with the revenue that the equipment usage will generate during that period, you can determine if leasing is profitable for your application. In addition, consider that the equipment's value at the conclusion of the leasing period depends on its condition.
When a lessor understands your business and industry, it will better be able to understand inherent market fluctuations and other aspects that change and determine your business needs.
Leases vary, and sometimes one can be tailored to fit your month-to-month or year-to-year cash flow needs. In fact, a key reason for leasing is that it offers the ability to customize a program to address your individual needs and requirements, such as cash flow, budget, transaction structure, and cyclical fluctuations. For example, some types of leases allow you to miss one or more payments without a penalty, which might be important if your business is seasonal.
Understanding your business's tax and cash flow requirements also is important. Lease payments are treated as expenses on your balance sheet, so the leased equipment does not have to be depreciated over five to seven years. The IRS does not consider an operating lease to be a purchase; it is a tax-deductible overhead expense. This allows you to deduct the lease payments from your corporate income.In addition, lessors need to know what the equipment will be worth at the end of the lease term for appropriate residual setting and for providing the best lease rates.
By asking this question, you will eliminate any misunderstandings about the number of payments; the total monthly amount due; and any additional costs related to insurance, taxes, and other charges. It is important to ask if any additional costs are associated with the lease, such as late-payment fees and other surcharges that may occur during the lease term.
Many businesses opt to sign a master lease. This is a contract that permits you to lease certain assets but also to have the ability to acquire additional assets under the same basic terms and conditions without negotiating a new contract. This lease type provides the maximum flexibility. If you want to terminate a lease earlier than originally contracted, additional payments might be charged. Lessors count on having assets be a part of their portfolios for a specific period of time. Suddenly being in possession of equipment they were not expecting can change their portfolio mix.
This important question will help you identify your liability for the equipment you are leasing. Ask whether you must pay for or replace lost or damaged equipment.
A lessor may assume the costs of insurance, taxes, and maintenance of the equipment. If it does, those provisions should be spelled out in the lease documentation. Ask your lessor to review these provisions with you.
If you do not opt for a master lease, you probably will need to negotiate a new lease contract for additional equipment. If you anticipate growth, you may be wise to negotiate an option to add equipment under the original terms and conditions when you structure the lease program. Also, determine if you want the option of the lessor handling installation, maintenance, asset management and tracking, and other services.
A lease finances only the value of the equipment expected to be depleted during the lease term. The lessee usually has options to return the equipment to the lessor, purchase the equipment at fair market value or a nominal fixed price, or renew the lease. Knowing which option you need and having it specified in the lease documentation are important. You also should ask how soon you would receive the title if you chose to buy the equipment at the end of the lease.
Find out whether you must return the asset to the lessor, as well as what documentation and packaging materials are required upon its return. You need to know who pays for shipping and when the equipment must arrive at the lessor's destination.
Before you sign, ask what additional costs could be incurred based on your account activity, such as late payments. Find out when they are due as well.
The more questions you can get answered upfront, the more time, money, and energy you will save during the lease term. Communicating about the lease's provisions will help create a positive, productive relationship with your lessor. Discuss any questions or concerns you have with your leasing company—no question should be left unanswered.
Organizations seeking more information about leasing, including a glossary of terms, types of leases available, and help in finding a leasing company, can visit www.leaseassistant.org.
Michael J. Fleming, CAE, is president, Equipment Leasing Association (ELA), 4301 N. Fairfax Drive, Suite 550, Arlington, VA 22203-1627, 703-527-8655, fax 703-527-2649, www.elaonline.com.