Finance or Purchase?
Many companies lease equipment because leasing provides
the best means of preserving working capital. By
leasing, a company can obtain the use of the most
equipment with the lowest cash outlay.
Frequently the questions of tax advantages, interest
rates, and financial structure arise. A prudent
decision maker only considers these issues to determine
how they will affect the use of working capital. A
savvy finance manager does not fall prey to the lure of
ownership of a depreciable asset. "Lease
that which depreciates and buy that which appreciates."
- J. Paul Getty.
Many decision makers think interest cost is the primary
consideration when deciding whether to lease, finance or
purchase the acquisition of equipment. There are
many simplistic computer programs to calculate the
difference between leasing and financing, using the
interest rate and the effective interest rate
as the only considerations. Few of these programs
employ any form of working capital analysis. The use of
working capital is far more important to the
business owner's profits than the interest cost.
To thoroughly answer this question, one must justify the
acquisition by calculating the operating profit the
acquisition will generate and then
determine the cost of acquisition. Then one must
objectively consider two perspectives:
First, business owners should consider the effect on their personal
assets and liabilities. Prudent business owners must know
this, or they might be forced to close their doors without knowing
exactly what effect that would have on them personally. Have they
honored all their obligations? Will their personal credit and
reputation suffer? If the company can pay cash for the proposed
asset, they have added an asset with no liability. A very safe
position, but to quote an unknown sage "A ship is safe in port but ships
aren't built for that". A capital asset should be acquired with
financing or leasing while keeping sufficient liquid assets available to
pay off any obligations created in the acquisition, keeping in mind the
worst case liquidation value of the asset.
second perspective is cost. What is the total cost of making the
acquisition? The normal rule: the lower the interest cost, the
higher the net profits. Many decision makers fall into the trap of
believing this is the only rule and look no further. It can be a
good rule, as long as the effect on the amount of their working capital
Which brings one back to the first rule of business: Working
capital is the most valuable tangible asset of a business and must
always be preserved for it best and highest use. The use of
working capital creates profit. Leasing allows for the best use of
the most working capital, which translates directly to more profit.
Leasing means lower cash outlay and effective reduction of tax
liability. Leasing provides ease of maintaining the most effective
means of production and also preserves and creates working capital
better than any other method of obtaining equipment.