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Choosing equipment for your small business can be equal parts exciting and stressful.
Apart from selecting the right type of equipment, there are many considerations to make when choosing between leasing and buying equipment that affect your small business accounting needs. These include upfront costs, maintenance costs and of course, tax implications.
When you lease equipment, it’s similar to paying rent for office space. You make flat monthly payments for use of an asset that you do not own. On the other hand, purchasing equipment involves the acquisition of an asset via capital investment or financing.
Leasing tends to be the more popular method for new small businesses who may not be in a position to make huge capital investments straight out of the gate. Others may have the funds available in the bank but realize that it may be more prudent to hold off on large capital expenditures until they break even. The breakeven point refers to the amount of sales you need to generate just to produce a profit of zero. In other words, it’s the amount you need to earn in order to keep the doors open and stay in business. To calculate the breakeven point use this formula:
In this equation, fixed costs are your regular recurring debits. This would include your monthly lease payment or loan payment if you choose to finance equipment.
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Apart from assessing start up costs and determining break even, it is also critical to give some thought to your company’s future technology needs. Some small businesses don’t require new technology very often, while others need regular updates to stay relevant in a competitive industry. In fact, the number one benefit of leasing is that it offers businesses the opportunity to upgrade equipment at the end of a lease period.
To determine how aggressive your need for updated technology is and whether or not it makes sense for you to lease or buy, use the following checklist:
Putting together cash flow projections on a regular basis is important to ensuring the long-term viability of your business. Looking at past performance is an excellent starting point. However, in making your forecast, you will need to include the impact of purchasing versus leasing equipment in your calculations.
Buying equipment affects the investing cash flow and operating cash flow sections of the cash flow statement:
On the other hand, a lease payment only affects operating cash flows. There is no need to worry about maintenance costs, etc. as these are handled by the lessor under the terms of the contract.
You can run scenario analyses to show how your cash flow would be impacted based on options to lease or purchase. The important takeaway here is to be able to anticipate upcoming events in your company’s growth journey.
For instance, if you are concerned about a new entrant in your market, you may prefer to hold onto your cash and go the route of leasing to provide you with more flexibility.
RELATED: How to forecast cash flow in QuickBooks
There are a number of common reasons why a small business may not qualify for financing equipment. This could be due to a lack of creditworthiness, but there are other conditions that lenders look at such as the length of time you’ve been in business and available collateral.
To understand your financing options, follow these steps:
From a tax perspective, deducting the cost of leased equipment can simplify the tax filing process for your small business when compared to deducting the value of depreciation. It adds a larger deduction than deducting interest on a credit purchase. For these reasons, leasing could be favorable.
Now that you’ve asked yourself the important questions, combed through your small business’s finances and talked to an accounting professional, it’s important to weigh the pros and cons of leasing versus buying for your business.
To complicate things further, you may also consider choosing between a capital lease and an operating lease. Capital leases are generally used for longer-term leases on equipment that is not expected to become obsolete in the near term. They are treated as an asset from the perspective of the lessee and a loan from the standpoint of the lessor. A capital lease gives the lessee the same benefits (and the disadvantages) of owning equipment.
An operating lease refers to an arrangement in which the lessee does not have any ownership rights to the equipment. The lease payment is recorded as an operating expense. An operating lease is usually beneficial in the case where technology needs to be replaced often.
Ultimately, this small business accounting decision must take into account a number of factors that small business owners should discuss with their trusted financial advisors.
In summary, these factors include:
If all of these considerations have anything in common, it’s that there isn’t a one-size-fits-all solution in terms of buying versus leasing. Small business owners may have an idea of what will work best for their business, but they should seek advice from professionals who can look at the big picture and offer advice.
Our team of small business accounting professionals will advise you on the necessary steps to make sure your equipment meets the needs of your business today and five years from now. Our goal is to make businesses profitable, and that means we do more than just taxes and bookkeeping.
In particular, Ignite Spot offers outsourced financial reporting services to ensure you have the right reports exactly when you need them. This will allow you to make more informed decisions and stay on top of your game.
The benefits of outsourced financial reporting include the following:
Contact our team today to learn how we can help meet your small business accounting needs.
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