It’s incredibly tough for businesses to survive in an environment that is as competitive as the one today. While some industries have higher failure rates than others, the reasons they may fail are quite similar. In fact, the most common reason small businesses, in particular, don’t succeed is due to cash flow issues. With 82% of small businesses failing for this reason, money is something businesses have to monitor with a keen eye.
Insufficient capital prevents businesses from retaining their competitive advantage and maintaining the quality of their products and services. This is exactly why it’s important for businesses to explore their financing options and equipment leasing is one of them.
What is Equipment Leasing?
Equipment leasing is an excellent way for businesses to attain the hard assets they need to run their business operations and possibly expand. Investing in new equipment isn’t cheap and it can be especially costly in an industry that’s continuously changing due to technological advancements.
Leasing allows you to obtain the latest machinery at an affordable rate; instead of investing a lump sum, you have to pay off the amount in monthly payments, giving you greater control over your cash flow. Moreover, many lessors don’t require a massive down payment.
Types of Leases
So, now that we’ve covered the basics of what equipment leasing entails, it’s important to know the different options available for your businesses. Here are seven different types you should know about:
This form of lease involves transferring the risks and benefits of the ownership of the leased property to the lessee and is an excellent option when you need equipment in the long run. The accounting for this will typically be an interest expense on the income statement and a long-term liability on the balance sheet.
In this case, the lessee has the authority to depreciate the equipment. Apart from this, there are certain criteria that an agreement needs to meet to be qualified as a capital lease, such as the term of the lease being equal to or greater than 75% of the useful life of the asset.
In contrast, an operating lease is more suitable for situations when you require the equipment for the short term. The nature of this lease is similar to renting and, at the end of the period, doesn’t involve the transfer of ownership of the asset.
Lease payments are considered operating expenses and accounted for on the income statement, thereby affecting the net and operating income, both. Since an operating lease is typically a temporary agreement, it does not transfer the risks and benefits related to the ownership of the equipment to the lessee.
Once the lease term ends, the lessee has the option to continue leasing the equipment or “re-leasing” it. Additionally, since these expenses are typically treated as rental payments, they’re 100% tax-deductible operating expenses.
Sale & Leaseback
This lease involves selling a hard asset owned by the lessee to the lessor for cash and rented back to the lessee. Sale and leaseback is an excellent option for when you want to free up capital that’s tied into an asset.
It also gives a business the option to retain ownership of the asset while freeing up some capital. Additionally, since the lessee has to make rental payments it gives them tax benefits instead of depreciating the owned asset.
If you’re looking for a lease with the lowest possible tax benefits and monthly payments, you should look into a stretch lease. It gets its name because the lease term can be “stretched” over extra months.
It also gives you the option to purchase the equipment in the middle of the term and avail of lower payments. Once the primary lease term ends, the lessee can extend the term of purchase of the asset.
Terminal Rental Clause Agreement (TRAC) Lease
This specific lease particularly involves “over-the-road” vehicles, such as trailers, trucks, and tractors and allows adjustments to lengths, residuals, and payment terms during the lease term. The TRAC also allows room for some flexibility by giving you the chance to negotiate your monthly payments and residuals. If, for instance, you prefer a higher residual and lower monthly payment, or vice versa, you can opt for that.
If the lessee chooses not to buy the equipment, they can sell it to a third-party too. If the lessor obtains a higher residual value than the agreed amount, they will give the surplus to the lessee. On the other hand, if the residual amount is lower than agreed, the lessee will reimburse the lessor.
Skip Payment Lease
This type of lease involves avoiding payments during slow months and adapting the agreement according to your business’s cash flow cycle. So, if your business has fluctuating cash flows, you can match your revenues to your expenses. If, for instance, the first payment of your lease is due in 120 days, it would be called a 120-day skip.
Equipment leasing is an excellent option for businesses to consider when they want to obtain new assets without making a heavy investment.
There are plenty of options available for your business to explore, so you’re bound to find something that suits your business’s needs. To fully determine which option is best, you should consult a specialist who can guide you through the process.