When business owners or managers need to acquire new equipment, they may spend enormous amounts of time poring over features, benefits and costs. However, it's unlikely that they spend as much time deciding how to pay for the acquisition.
There are a few options businesses have when it comes to procuring new equipment, including cash, leases, or loans. From tax advantages to total cost of ownership, choosing the right option based on the type of equipment, financial state of the business, and other factors can result in important bottom-lines.
Acquisition Financing Options
1. Paying Cash
One option for acquiring new equipment is to pay cash. However, cash can be scarce and businesses may have strategic reasons to look for other ways to finance their purchases.
2. Leases or Loans
As a result, roughly 80% of U.S. businesses opt for leases or loans to finance equipment purchases, according to the Equipment Leasing and Financing Association (ELFA), a leading trade organization.
Equipment loans are a straightforward way to purchase equipment. They are usually much like loans for a car or a home. Lenders may wish to see the company's balance sheet, credit profile and, sometimes, those of the owners or partners.
After the loan approval and closing, the business will be responsible for making payments according to the terms of the loan.
Leases can offer an excellent way for many businesses to acquire the equipment they need while minimizing the impact on cash flow. Most leases are operating leases that allow the business to pay to use the equipment for a specific period of time, much like renting.
3. Operating or Capital Leases
Sometimes, operating leases can have flexible payment terms based on seasonal income or other business needs. At the end of the lease, the business may have a buyout option or may choose to return the equipment to the lessor.
Capital leases are structured like equipment loans, typically having a small buyout at the end of the lease—sometimes as little as a dollar.
Each payment method has big-picture financial considerations.
Paying cash may deplete the company's liquid assets, so it's not an ideal option if the company doesn't have sufficient cash on hand to both make the purchase and ensure that cash flow remains stable over time.
Equipment loans are available from a variety of sources, including through the seller's financing options and from banks or other lenders. Interest rates may vary from lender to lender.
According to ELFA, an equipment loan may require a down payment, as well as other collateral, depending on the financial stability and credit history of the business.
Operating leases and capital leases differ in a few distinct ways.
The operating lease may end after a few years, allowing the business to upgrade equipment. Operating leases may also offer lower monthly payments with more flexibility at the end of the lease.
If your business acquires the equipment through an operating lease followed by a purchase, the initial lease lets you reduce the upfront cost of acquisition. Capital leases, on the other hand, act like a purchase with an equipment loan, and may require larger fixed payments.
Changing Tax Implications
It's also important to keep up with changing tax implications.
Traditionally, through section 179 of the federal tax code, you could claim the cost of qualifying equipment in the year you bought it, up to a threshold of $510,000 in 2017.
However, if the cost of property placed in service exceeded $2,030,000 in 2017, the deductible amount began to phase out.
If the acquisition fell within Internal Revenue Service (IRS) guidelines, a purchase or capital lease could reduce your company's taxable income.
However, the Tax Cuts and Jobs Act of 2017 expanded bonus depreciation.
Businesses may elect to take a 100% first-year depreciation deduction for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (after September 27, 2017, and before January 1, 2024, for certain property with longer production periods), according to Thomson Reuters.
Equipment Acquisition Options
The choices about which acquisition option is right for your business is complex, but there are some basic guidelines for each.
- Consider cash when it makes sense to purchase and hold the equipment, and when depleting your cash on hand will not adversely affect the business. Cash purchases may allow you to negotiate for a better price more effectively and will save on fees, interest and other costs typical of loans and leases.
- Consider equipment loans or capital leases when you want to keep the equipment for a longer period than a typical operating lease. In some cases, a particular financing company may only offer one type of financing or the other, depending on the financial products it offers, so you may need to choose the one that is available to you. These options may work well for highly customized equipment specifically built or modified for your business.
- Consider operating leases when you're planning on upgrading equipment regularly and want to minimize the impact on your company's cash flow while maintaining greater flexibility at the end of the lease. For example, you may opt to lease copiers or computer systems that may have significant technological advances in a few years, where your company can qualify for an upgrade.
Optimizing your business' mix of short-term and long-term can improve your company's buying power and ensure it can acquire what it needs to function and grow.
It's also a good idea to consult a tax or financial professional who can help you make the best strategic decision for your company.