Is it better to buy equipment outright or to lease it? What are the tax implications or benefits and the effect on the business? This guide helps you explore your options to arrive at the right decision for your business.
The decision to buy or lease
The decision to buy or lease equipment for your business depends upon the nature of your particular business, but there are nevertheless a few guidelines you can follow to help you decide what you should do.
If you have the money available, and the item is really necessary to your business, then it will usually benefit you to buy it outright. If there is no way you can find the finance (i.e. you have no money or the capital item is very expensive and you do not want to tie up large amounts of cash) then you will have to finance the purchase out of cashflow, which may mean leasing it.
Alternatively, if you don't have the cash available or, you choose to fund the purchase by a line of credit - discuss the long or short term funding options available with an ANZ Business Specialist.
If the options are not so clear-cut, then you have some thinking to do.
Ask these questions:
How often will you use the item?
If the item is only going to be used every now and then, there is no real point in buying one. It will lie around for most of the year unused and is therefore a waste of your resources. So lease or hire the equipment when you require it.
What else could you do with the money?
Could you earn a better rate of return on the capital required for the item if you invested it in your business? 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. For example, could you get better use out of the money by spending it on marketing or exploring new opportunities?
In this case, it might pay you to lease.
Consider 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 - and then only if it really is 'surplus', not just temporarily in your bank account. You should work this out through a cashflow forecast that takes into account your forthcoming liabilities.
The effect on your net profit
Now look at how your decision to buy or lease will affect net profit. For illustrative purposes only, let's take an example and calculate the net profit results for both options. Suppose you decide the business needs a machine worth $20,000 (we'll ignore GST for the purposes of this example). You can either buy the machine outright or lease it (rent).
If you lease, the machine might cost you around $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).
If you buy the machine, the total cost of $20,000 cannot be deducted from revenue as an expense, as the machine will now be regarded as an asset (forming part of your business capital). Suppose you can depreciate the machine at 20% a year. This means you can claim $4,000 as an expense for the year ($20,000 x 20% = $4,000).
Option One (leasing)
You've spent $6,000 in cash (at $500 a month rental), and can claim this $6,000 as a deductible business expense because it is a lease, not a capital purchase. By claiming $6,000 as expenses, you'll pay less tax (as opposed to not having the machine at all) of $1,680 (assuming a tax rate of 28% - the company tax rate). So you could say that you've spent $6,000 and 'saved' $1,680, giving a net cash out for the business of $4,320 for that tax year.
Option Two (buying)
You spend $20,000 in cash, and claim $4,000 as a depreciation expense, which gives you a tax 'saving' of $1,120 (28% of $4,000). So your net cash out is $18,880 ($20,000 less $1,120).
Therefore, in the first year, it would have been better for the business, as far as cashflow is concerned, to have leased the machine rather than purchasing it.
But what about year two?
In Option One you'd still have to pay $6,000 in lease costs for that second year, and the net cash out is still $4,320.
But in Option Two, you have no further cash to pay (the machine is now yours), but you can still claim depreciation of $4,000 (assuming a straight-line form of depreciation), which gives you a 'saving' of $1,120. This comparison shows, therefore, that whilst you might have gained a slightly better cashflow situation in year one, the lease option becomes far less attractive in subsequent years.
So as a rule of thumb, if you lease equipment you will spend less cash in the first year or two, (as you do not have to pay the full price) and this is a viable alternative if you do not have the cash (especially for equipment that may cost thousands of dollars, or items you do not use regularly). However, long term, it's much better to buy equipment outright, provided you can safely ride out the initial heavy cash commitment, and it is going to be a productive piece of equipment over time.
Some further considerations
A bank loan versus leasing
If you choose to lease, consider getting a bank loan for the equipment instead. For example, suppose you need a high-quality colour laser printer that costs around $10,000.
If you ask the dealer to quote for the monthly costs of leasing the printer for three years, you'll typically find that there is not much difference between the monthly payments of a bank loan versus leasing.
Why then would you want to lease, where you never end up owning the asset? Obviously leasing suits the seller best, because at the end of the leasing contract, (say three years) they can persuade you to lease another machine. If you don't, you lose the use of the equipment, because with leasing you never own anything. So as long as you need the printer your leasing payments will go on, years after year. But does it suit you best?
The argument for leasing is typically that you will always have the latest technology. This may sound attractive, but remember that the three-year old machine does have some residual value. The leasing company will usually dispose of it on the second hand market. Why should you not benefit from that residual value? In addition, although getting a brand new machine every three years might sound enticing, you might well be able to get another few years of good service out of the equipment, particularly if you buy quality equipment in the first place.
In the case of the laser printer, you might reckon on getting six years of good service from the machine. After the third year, you pay nothing further (apart from maintenance costs). If you work out the amount you'll save over that three to five year period, the difference could end up being a tidy sum.
You could also check with the equipment dealer about a lease to own option, where you do own the equipment at the end, but you will probably end up paying a higher lease fee.
A better alternative to dealer hire purchase
If you're considering the hire purchase option, speak to your Business Banking Manager about a suitably structured bank loan with an agreed repayment period. The interest charges will work out significantly lower than the commercial hire purchase rates that the equipment dealer is likely to quote you, and the interest that you pay for business use equipment is tax deductible.
Budgeting for equipment
Over the longer term, it is good business practice to budget for capital item purchases or replacements. This is particularly true of technology equipment that is likely to be obsolete within five or six years. It makes good sense to speak to an ANZ Business Specialist about opening a separate savings account for equipment and putting 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. In addition tax laws (such as those relating to the leasing to own option) can change. Advice from your accountant will help you make the best decision for your business.
This material is provided as a complimentary service of ANZ Bank New Zealand Limited ("bank"). It is prepared based on information and sources the bank believes to be reliable. It is subject to change and is not a substitute for commercial judgement or professional advice, which should be sought prior to acting in reliance on it. To the extent permitted by law the bank disclaims liability or responsibility to any person for any direct or indirect loss or damage that may result from any act or omission by any person in relation to the material.
This material is for information purposes only. Its content is intended to be of a general nature, does not take into account your financial situation or goals, and is not a personalised financial adviser service under the Financial Advisers Act 2008. It is recommended you seek advice from a financial adviser which takes into account your individual circumstances before you acquire a financial product. If you wish to consult an ANZ Business Specialist, please contact us on 0800 269 249.