The classic question most individuals and business owners face at one point or another – whether to buy or lease – comes up in many scenarios, from purchasing a new car to acquiring industrial equipment. Many people believe buying a car instead of leasing is the smarter choice, as they believe there is more benefit in owning the car once it’s paid off, rather than turning it in for a new model and extending the payment schedule. Before discussing which option is better, let’s first talk about the purpose of leasing.
The Ins and Outs of Leasing
Leasing is really just another form of financing the use of a long-term asset. If your business needs an asset for operations and you don’t have the cash, you can borrow money from a financial institution, or you can lease the asset if it’s available from a lessor. Either of these two options will result in the purchaser incurring an interest obligation. As well, with any asset purchase, the purchaser incurs some amount of risk – that the asset won’t work as efficiently as expected or that the asset becomes obsolete sooner than expected. Ultimately, the purchaser wants the investment in the asset to generate a positive cost-benefit analysis.
If choosing the leasing option, it’s important to remember that the lessor faces the risk that interest rates will increase and that he or she will want to make a fair return on the asset. They will need to negotiate the deal and they will need good information to back their position.
Based on these comments, do you lease or buy? It comes down to the classical statement, “it depends”. It depends on your situation and the asset that you need.
Leasing vs. Purchasing a Car
If you’re looking to acquire a new car, you need to consider several variables. It’s important to shop around and compare interest rates and potential incentives offered by a range of dealers. Talk to various suppliers of the vehicle to find out what their prices are. Following that, talk to your contact at your bank; see if the contact can give you a good idea of the interest rate that the vehicle dealership is paying on the money that they have borrowed to finance the purchase of their inventory. This interest is part of the cost that the dealership needs to recover on each vehicle that it sells. Estimating how much profit a dealership stands to earn from a given purchase is not something that is easy to do. You will need to get prices from several dealers and any information on markups will be difficult to obtain but very valuable.
Rapidly Evolving Technology
If you are considering leasing specialized equipment needed for your business (i.e. medical equipment, computers), your biggest concern should be how fast the specific technology changes. Dentists, for example, who want to sell their practice when they want to retire know that there is a limit of what they can charge for equipment that is considered out date and in some cases, obsolete. In this case, it’s better to lease the needed equipment as its value will be very low at the time of retirement.
Changing Interest Rates
As mentioned earlier, interest rates are also an important consideration. The current situation of low interest rates makes it easier to finance a purchase or lease an asset. This makes it tempting to buy assets that will make one’s business more competitive and create a competitive advantage. On the other hand, the current economic conditions brought on by the pandemic could indicate that this is not the time to invest in new equipment. Putting these two aspects together, every business needs to monitor economic conditions and government responses to the pandemic in order to determine their best path forward. Will your business have a plan in place for when the economy improves? Now is a good time to talk with a professional if you need help in putting together this plan.
How Does Leasing Affect a Business’s Bottom Line?
Another topic to consider if you are thinking about leasing equipment for a business is what will be reported on your Statement of Financial Position (also called Balance Sheet). At one point in time, accounting rules asked that leases that really represent an acquisition of assets be shown as both a long-term asset and a long-term debt. This additional long-term liability resulted in an unfavourable impact on an organization’s debt-to-equity and debt-to-assets ratios. Many companies would ask lessors for terms that would not represent a long-term asset acquisition so that the lease could be classified as an Operating Lease. By doing this, the lease obligation would not be reported on the Statement of Financial Position. The latest recommendation from Canadian Accounting groups is that the lease obligation is reported as a contract liability. This means that if you are deciding to lease a long-term asset so that your long-term debt will not increase, this can no longer happen.
Contact Edelkoort Smethurst CPAs LLP in Burlington for Advice
The option of whether to lease or to buy ultimately comes down to several factors, unique to each individual or company; unfortunately, there is no one ‘correct’ answer. There are several variables to consider and getting advice from a professional can be a considerable help. Please contact the Chartered Professional Accountants at Edelkoort Smethurst CPAs LLP by calling 905-517-2297 or by contacting us online. Their consulting expertise will help you make the best decision for you and your business.