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Benefits of Leasing for Customers
The ABC's of Leasing
A lease is simply a contract which the owner of a piece of property gives someone else the right to use it for a certain period of time, and for a certain payment. At the end of the lease, the user can renew the contract, buy the equipment or return it to the owner. Some installment sales contracts are called "leases" too because they contain important elements of leasing - things like no money down, longer terms or a flexible payment schedule. Installment sale, conditional sale or lease-purchase contracts are especially common when it comes to acquiring typewriters copiers, personal computers, telephones, job printing presses and other "small-ticket" equipment.
The growth of small-ticket leasing (equipment under $25,000) is explosive. Small tickets account for at least one quarter of leasing's $100 billion volume, according to Michael J. Fleming, president of the American Associating of Equipment lessors. Whether it is a true lease or a purchase contract that looks like a lease, everyone—vendors, users and financiers - prefer to call it a lease. Leasing has become a buzzword.
Advantages of Leasing
Huge companies with many divisions often have a cumbersome process for approving large capital outlays. Expenditures that affect the balance sheet have to pass muster with the capital budget committee, which may meet only once a year. That is bad news for the division manger who suddenly needs a big piece of equipment, because his part of the business has grown way beyond what he expected when he submitted his annual budget. Leasing can help him get out of this bind. An "operating" lease can be recorded as an expense rather than a capital outlay.
"One of the biggest reasons people lease today is budgetary," says John J. Walters, president of DPF Group, Ltd., a leasing company that specializes in high-tech equipment. "You go in the capital committee and say: "I need a $5 million computer"; They say: "It's not in the budget for this year. Go lease it."
Fixed Rates
The balance sheet was not one of the reasons by Primex Plastics Corp. chose to lease rather than own four extruders, at Primex's Garfield, N.J. headquarter and three other plants. The machines turn plastic resin into plastic sheets. As a closely held company, Primex can't raise capital by selling stocks or bonds on the public markets. So its options for acquiring the $2 million worth of equipment came down to these: pay cash, borrow from the bank, or lease. In the case of the extruders, Primex opted to lease, from TriContinental Leasing Corp., a subsidiary of Bell Atlantic Corp.
"We're profitable, so we do have ready cash," says Glen J. Ruffino, Primex's controller. "But we'd rather invest our cash in operating our business or expanding it, in hiring more labor or adding more space to our plants. That's why we like to leave our bank lines open, too. You always want to keep some kind of bank financing in your pocket, in case you need it."
Ruffino also likes the certainty that TriContinental's fixed-rate lease gave Primex. Bank loans usually have a floating rate of interest. "Floating is very nice when rates are coming down. But how low can rates go? It's got to end sometime," says Ruffino.
Short and Long
Leasing companies often are willing to put out money longer than banks. This means that for durable equipment, the user can more closely match his payments to his income from the machine. The equipment pays for itself over the life of the lease. If, on the other hand, the user knows he's only going to need the equipment for a short period of time, or if he's worried about technological change, he can choose a short-term lease. Again, he'll be paying for the equipment for as long as he's using it, and no longer.
While the investment credit helped reduce some lease rates, it also tended to make lease terms more rigid. Since an equipment owner needed five years to earn the full ITC, leasing companies preferred to write five-year leases, whether or not five years matched the useful life of the asset. Thus the ITC acted as a kind of a golden straight jacket.
"We've done a lot of business triggered around five years, regardless of the useful life of the equipment," says William J. Montgomery, President of Xerox Credit Corp. "Fork lifts usually last a long time. There is no reason anymore why a lease on a forklift should be for only five years. With the investment credit repealed, flexibility has been restored to the term of a lease."
Some of the Many Reasons to Lease Rather than Buy
Advantages for the Customers
- Leasing provides 100% financing - conserves working capital.
- For longer (or shorter) terms - Leasing companies often are willing to put out money longer than banks. This means that for durable equipment, the user can more closely match his payments to his income from the machine. The equipment pays for itself over the life of the lease. If, on the other hand, the user knows he's only going to need the equipment for a short period of time, or if he's worried about technological change, he can choose a short-term lease. Again, he'll be paying for the equipment for as long as he's using it, and no longer.
- Keeps credit lines open for other uses.
- Avoids use of short-term bank lines, conserving borrowing capacity for financing inventory, accounts receivable and other short-term .
- Conserves cash - prevents you from having to make large cash outlays. This is why Primex Plastics Corp. chose to lease rather than buy four extruders for its plants. As a closely held company, Primex can't raise capital by selling stocks or bonds on the public markets. So its options for acquiring the $2 million worth of equipment came down to these: pay cash, borrow from the bank, or lease; they chose to lease. As they stated, "We're profitable, so we do have ready cash. But we'd rather invest our cash in operating our business or expanding it, in hiring more labor or adding more space to our plants. That's why we like to leave our bank lines open, too. You always want to keep some kind of bank financing in your pocket, in case you need it."
- Lets someone else take the risk obsolescence - while you have use of state-of-the art equipment.
- Provides tax opportunities - Lease payments may qualify as an "operating expense" thus providing tax-expensing advantages.
- Leasing is convenient - it enables an immediate sale without making the customer go to the bank. It can all be done over the telephone.
- Flexible - provides, flexibility with regards to amount financed, payment structures, and other terms.
- Provides intermediate-term financing, longer than most bank lines, but shorter than most private placements.
- Provides a new source of funds, often enlarging the pool of capital available to your company, which can be particularly attractive during periods of expansion or when "tight" money conditions exist.
- When long-term interest rates are unattractive leasing can be used to delay permanent financing until rates improve.
- Avoids working capital, net worth, dividend and other restrictions common to most other types of intermediate and long-term financing.
- Allows the lessee to trade the value of depreciation for lower effective interest rates.
- Provides lower cost of financing on larger equipment purchases, when the lessor can "leverage" the tax benefits.
- Provides for the acquisition of needed equipment that had not been foreseen in capital budget planning. Expenditures that affect the balance sheet have to pass muster with the capital budget committee, which may meet only once a year. That is bad news for the division manager who suddenly needs a big piece of equipment, because his part of the business has grown way beyond what he expected when he submitted his annual budget. Leasing can help him get out of this bind. An "operating" lease can be recorded as an expense rather than a capital outlay.
- Can be recorded off the company balance sheet
- Frees funds for ownership of appreciating asset such as real estate.
- Allows for the payment of the equipment out of earnings rather than equity capital.
- Fixed rates. Fixed rates provide certainty. Bank loans usually have a floating rate of interest. Floating is very nice when rates are coming down. But how low can rates go? It's got to end sometime.
- Most companies lease for reasons that have nothing to do with taxes. One recent survey of people involved in making company lease-buy decisions showed several non tax reasons. Of those who said they leased, among 54 respondents whose company currently leases equipment, 61% gave non-tax reasons: cash flow advantage, better asset management, convenience, and accounting/balance sheet reasons. Only 28% said they leased for the tax benefits.
- These are the reasons why American business leased $150 billion worth of equipment in 1987. These are the reasons why American business leased close to $200 in 1988, despite the uncertainty caused by the tax bill's ups and downs.
- When business reaches beyond retained earnings to acquire capital equipment, it reaches most often for leasing. One third of all equipment acquired with external funds is acquired through leasing. Leasing is bigger than stocks, bigger than bonds, bigger than bank borrowing, bigger than commercial mortgages.
- And leasing is the fastest-growing form of equipment finance. Over the past decade, the volume of equipment leasing has increased six-fold.
Advantages for the vendors:
- No risk of bad debts. Collection problems are eliminated—they are handled by the leasing company. If the customer fails to make payments, its our problem.
- Increased sales. Leasing encourages multiple, larger sales. Because less cash and credit are being tied up by the purchase, the customer has more freedom to purchase special features, components or more equipment.
The Benefits of Leasing
- Funding Benefits
- Cash Flow Benefits
- Improved Cash Flow
- Fixed Payments
- Cost Efficient
- Payment Profiles
- Accounting Benefits
- Tax Advantages
- Equipment Benefits
- Technological Change
- Choose the Equipment Needed
- Easy Equipment Disposal
- Convenience
- Flexibility
- Preservation of Working Capital
- Maintains Open Bank Lines
- Tax Savings
- Matching Income to Expense