Leasing Equipment Can Make Sense Despite Costs
TEC Worldwide is an international organization of more than 7,000 business owners, company presidents and chief executives. TEC members meet in small peer groups to share their business experiences and help one another solve problems. The following questions and answers are based on recent TEC meetings in Southern California.
Question: I need to upgrade some production equipment in our small manufacturing firm. The last time I did this I got burned, sinking $500,000 into machinery that became obsolete before I paid it off. This time I’m thinking about leasing instead of buying. What are the advantages of leasing over an outright purchase?
Answer: Given how quickly technology can change these days, it pays to think twice before sinking large sums into a fixed-asset purchase.
First, take a hard look at what is happening in your industry. If it looks like new technology will replace the old before you can get a return on your investment, it may make more sense to lease rather than buy. The key is to avoid getting forced into the high-cost producer position by competitors who come into the market with newer technology and lower production costs.
Leasing offers several important benefits under the right circumstances. According to Ron Fleisher, president of Creative Bottomline Solutions in Atlanta, it transfers the risk of loss, resale and disposal to the lessor. When the equipment becomes obsolete, you simply return it to the vendor rather than try to unload it on the market for pennies on the dollar.
Leasing also reduces short-term obsolescence and provides the flexibility to react to technology and market changes. Finally, it helps to preserve short-term capital by avoiding large cash outlays.
On the downside, leasing usually costs more in the long run. Plus, your balance sheet takes a hit. Your payables increase, but because you don’t own the asset, it doesn’t show up on the balance sheet.
To many, this runs counter to the old school of thought that says hard assets belong on the balance sheet. But this is a risk management, not a balance sheet, issue. Leasing may cost more in total dollars, but what you’re really buying is protection against sudden technology changes.
If you decide to lease, make sure the contract includes favorable maintenance and “swap-out” clauses. If the equipment malfunctions and the vendor fails to fix the problem within a reasonable time frame, the lease should allow you to get the equipment fixed somewhere else and charge it back to the lessor. Otherwise, you run the risk of expensive down time. The contract also should allow you to exchange and/or upgrade the equipment if it becomes obsolete before your lease expires. If the vendor refuses to offer a swap-out clause, don’t sign the lease.
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If there is a business issue you would like addressed in this column, contact TEC at (800) 274-2367, Ext. 3177. To learn more about TEC, visit https://www.teconline.com.
