The decision to buy or lease
Both of these options have tax implications and will therefore impact your bottom line – but whether you should buy or lease equipment depends upon the nature of your particular business. Nevertheless, there are a few guidelines you can follow to help you decide what’s right for you.
How often the item will be used
Cash flow is precious. If an item is going to spend most of the year unused, it might be a waste of your resources. In this case, it might be best to lease or hire the equipment when you require it – so you’re only paying for what you use.
Opportunity costs
Could you earn a better rate of return on the capital required for the item if you invest it in your business? For example, spending it on marketing or exploring new opportunities.
Your business might be at the stage where spare cash ploughed back in as working capital will give you a far better rate of return than tying up the money in equipment. In this case, it might pay to lease.
Your working capital
If you want to buy the item, don't do so at the risk of not being able to meet your bills. Only use surplus cash – as long as it really is 'surplus', not just temporarily in your bank account. To make sure it is surplus cash, you should work this out through a cash flow forecast that takes into account your forthcoming liabilities.
The effect on your net profit
Look at how your decision to buy or lease will affect the net profit of your business. This example illustrates how this works – and why it’s important to take a long-term view.
An example scenario
You decide your business needs a machine worth $20,000. You can either buy the machine outright or lease (rent) it.
For the purposes of this example, we’ll ignore GST. We’ll also assume a tax rate of 28%, which is the company tax rate.
Option 1: Leasing
Leasing the machine costs you $500 per month, or $6,000 for the year. This can be added to your business expenses, as lease costs are fully deducted as an expense.
By claiming $6,000 as expenses, you pay less tax (as opposed to not having the machine at all) of $1,680 (28% of $6,000).
After year one, you’ve:
- Spent $6,000
- Saved $1,680
That gives a net cash out for your business of $4,320 for that tax year.
Option 2: Buying
You spend $20,000 to buy the machine. This can’t be deducted from your revenue as an expense, as the machine is now regarded as an asset (part of your business capital).
But now you own the machine, you can depreciate it – for this example, we’ll say at 20% a year. This means you claim $4,000 as an expense for the year ($20,000 x 20% = $4,000). Your tax saving is $1,120 (28% of $4,000).
After year one, you’ve:
- Spent $20,000
- Saved $1,120
That gives a net cash out for your business of $18,880.
Comparative costs – year one vs year two
Based on our example, in year one it would have been better for the business – from a cash flow perspective – to have leased the machine rather than purchasing it.
But here’s what happens in year two:
- Option 1 – you still have to pay $6,000 in lease costs for that second year. The net cash out is still $4,320.
- Option 2 – you have no further cash to pay. The machine is now yours. However, you can still claim depreciation of $4,000 (assuming a straight-line form of depreciation), which gives you a ‘saving’ of $1,120. And this continues, year after year.
This comparison shows that while you might have gained a slightly better cash flow situation in year one, the lease option becomes far less attractive in subsequent years.
Summary
As a rule of thumb, if you lease equipment, you’ll spend less cash in the first year or two, as you don’t have to pay the full price. This is a viable option if you don’t have the cash, especially for equipment that costs many thousands of dollars and/or isn’t going to be used regularly.
In the long term it’s much better to buy equipment outright if you can, provided:
- You can safely ride out the initial heavy cash commitment
- It’s going to be a productive piece of equipment over time.
Other considerations
Bank loan versus leasing
If you choose to lease, consider getting a bank loan for the equipment instead. A bank loan could potentially enable you to own the asset for a similar cost to the lease. Our guide to loans vs leasing breaks down the benefits.
Budgeting for equipment
Over the longer term, it’s good business practice to budget for capital item purchases or replacements. This is particularly true of technology equipment that's likely to be obsolete within five or six years.
It makes good sense to open a separate savings account for equipment and put aside a regular sum each month or each quarter to take the sting out of equipment purchasing.
Talk to your accountant
Before you make any final decision about buying or leasing equipment, you should also talk to a qualified accountant (and/or tax adviser) about the particular circumstances of your business.
Tax laws, e.g. those relating to the ‘leasing to own’ option, can change. Advice from your accountant will help you make the best decision for your business.
Alternatives to buying outright or leasing
If you don’t have the cash available, you might be able to fund the purchase by a line of credit. Discuss long-term and short-term funding options with an ANZ Business Specialist.
Contact an ANZ Business Specialist
Our specialists understand your kind of business and the challenges you face as a business owner. We can help you figure out how to make your business grow and succeed.
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