Small businesses have to be careful with their capital, and one of the costliest start-up expenses that a business has is obtaining the equipment it needs to reach its full potential. Purchasing equipment outright can be expensive, and getting financing to make equipment purchases is often a challenge.
Leasing equipment is sometimes an attractive alternative, in part because of tax benefits and in part because you might be able to pay lower monthly payments than you would with a purchase loan. However, if your equipment will have residual value at the end of the lease term, then the extra amount you have to pay going forward can sometimes turn leasing into the less attractive option.
How the buy vs. lease question usually works
Here's how the situation usually plays out when you look to get business equipment. You can buy the equipment on your own, getting financing that you'll have to pay back over time. Once the loan is paid off, the equipment is yours, and you can either sell it, or use it beyond the term of the loan.
Alternatively, you can lease the equipment. You'll typically make an upfront lump-sum payment under the terms of the lease, and then you'll have to pay monthly lease amounts throughout the lease term. When the lease is over, you either return the equipment to the seller, or make whatever payment is necessary under the lease terms.
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Many people like leases because they make it simpler to get regular upgrades to new equipment. At the end of the lease, they simply return the old equipment and enter into a new lease for the latest model. For them, leasing avoids the hassle of having to sell their equipment secondhand, because the pricing on the lease takes into account anticipated residual value at the end of the term.
However, from a financial standpoint, the more important question is what terms you can obtain either on a purchase loan, or through a lease.
Calculating the best answer
To compare leasing with buying, it helps to have a calculator. The following one does a good job of breaking down the various options and showing you which one is more attractive from a cash-flow standpoint.
Editor's note: The following language is provided by CalcXML, which built the calculator below.
* Calculator is for estimation purposes only and is not financial planning or advice. As with any tool, it's only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or tax professional.
To see how this works, let's start with a basic example. Say that you're looking to acquire equipment worth $10,000. You can get a 36-month loan at 6% to buy it outright, or you can get a 36-month lease at $253 per month. The equipment will be worth about $2,000 at the end of the 36-month period.
When you run the numbers through the calculator, you'll find that purchasing the equipment is the better option. The loan costs you $304 per month, or about $50 more than the lease. However, at the end of 36 months, the loan gives you possession of equipment worth $2,000. That more than makes up for the $1,830 more in loan payments you make over the course of that time frame.
However, this example shows the importance of the assumptions that you make. The lease essentially guarantees that the residual value will be treated as $2,000, regardless of whether you could actually get that on the open market. By contrast, if you buy the equipment, then you're responsible for figuring out a way to sell it for $2,000. If you're only able to sell it for $1,500, then you would have been better off taking the lease all along.
Be smart about getting equipment
The questions you should ask if you're looking to get business equipment boil down to whether the residual value of the equipment will be enough to offset the lower lease payments over time, and whether you're comfortable holding onto the equipment past the term of the lease, or will prefer to sell it for newer equipment.
Your best decision on whether to lease or buy your equipment will depend on how you answer those questions. Knowing the financial aspects of the situation is important, but nonfinancial aspects could end up being more important to your decision-making process.
