Lease companies have very streamlined appication processes that are designed to require very basic information for smaller ticket deals, with information requirements increasing with lease request complexity. As an example, for amounts requested under $25,000, the application can be completed in just a few minutes and an approval received in as little as an hour via electronic scoring systems specifically designed for speed. With higher value requests, more information will be required with approvals being issued in one to 3 business days in most cases. Compared to an equipment loan process that tends to require the same amount of information and time process an application, the leasing process is noticeably faster.
One of the reasons for the faster process is due to the demand by customer to have a faster process in order to take advantage of opportunities to purchase equipment when items come available and to reduce business down time when replacements are required. Another reason lies in the fact that the leasing company ends up owning the underlying security and they will also only focus on equipment they feel comfortable liquidating, allowing for a quicker assessment of any financing request.
Cash tends to be a precious commodity in any business, and the ability to create a higher level of financial leverage at reasonable costs is important to manage cash flow and acquire the necessary assets to run the business. For equipment leasing, leverage or the percentage of the asset value that can be financed, is as high as 100% in most cases. In cases where delivery, installation, and training costs are involved with the asset purchase, these related soft costs can be financed by the lease as well, effectively providing greater than 100% financing.
And by being able to access lease financing, a business can keep their line of credit and cash supply available for working capital and other requirements.
An approved equipment lease will be repaid through an amortized payment schedule that remains fixed during the entire lease period. The lease term can also be matched to the timing of the real depreciation of the equipment so that you’re only paying for the value being consumed versus paying for equity in the equipment that can’t be expensed until much later into the future. As a result, the lessee can more accurately manage cash flow and project future cash flow requirements including when asset replacements or upgrades will need to be made.
When you purchase an asset for cash, you are required to pay all the point of sale taxes at that time. With equipment leasing, the lease company is the one purchasing the asset, so they pay the taxes at the point of sale and the lessee only pays taxes on each lease payment as they come due. This creates a deferment of taxes which reduces the amount of cash outlay that is required at time of purchase.
Operating leases and capital leases have different accounting both for the business financial statement and income tax planning. Based on the nature of the business, there can be advantages to considering different types of leasing programs to get the most tax and accounting benefits. For instance, a capital lease is treated more like an equipment loan for accounting and taxation purposes, while an operating lease can allow for 100% of the lease payment to be classified as an operating expense.
Commercial Equipment Leasing products can cover many different types of asset types that are utilized by going concern businesses.
A commercial equipment lease, or business equipment lease can finance asset purchases of as low as $1,000 in some cases to several million dollars in cost.
The key difference between consumer equipment leasing and leases for commercial equipment is the variety of assets that are considered for financing.
Every industry has its own equipment usage needs and the related cost need to be financed by some combination of cash, loans, or leases. For commercial leasing to be available for an asset type, the asset needs to have both significant sales in the market on an annual and ongoing basis as well as a resale and/or disposal market for used equipment.
If these conditions exist, then its very likely that a commercial leasing source will be available to business owners that wish to acquire the product.
Commercial equipment lease programs tend to be very focused on a particular slice of the market. Some companies will only consider equipment financing applications of less than $150,000 while still others will concentrate on larger sized equipment financing requirements.
Some leasing companies can be very focused on certain types of equipment while other companies can be very broad based in terms of what they will consider financing.
One thing that is for certain is the more volume and variety of an equipment type sold into the market, the more commercial equipment financing options will be available.
Commercial equipment leasing can also range in cost from bank prime plus effective lending rates to lending rates climbing into the high teens. Higher rates relate to higher risk and lenders that are prepared to provide equipment leases that are higher risk in nature typically will have a strong liquidation pathway for the equipment. What this effectively means is that the leasing company has very in depth knowledge of the equipment resale market and understands exactly how to dispose of the equipment that is financed and what is the likely sale value they can receive under a forced liquidation scenario.
The higher risk lenders tend to be vertically integrated with equipment resellers and auction services that provide the means for disposing of equipment in the event that a lessee defaults on the lease and a collection action needs to be undertaken.
While low risk commercial equipment leasing companies have the same concerns when it comes to managing risk, their focus is more on the financial strength of the overall business and the business owners.
Equipment leases under $25,000 are approved in a similar fashion to consumer financing whereby the decision to approve a lease application is largely based on credit history and stated income. As the the amount of lease financing requested increases, the more information will be required to support an approval. Once applications get into the hundreds of thousands of dollars, multiple years of accountant prepared financial statements will be required along with accounts payable and accounts receivable ledgers, customer contracts, supplier contracts, business plans, cash flow projections, and anything else that would support the case for financing.
And like consumer lease financing, business equipment leasing can cover off 100% of the asset cost, making it a highly leveraged and cash flow friendly form of financing.
Depending on the country you live in and the related tax jurisdiction, the definition of operating and capital leases can vary for accounting and income tax purposes.
In Canada, an overview of the related definitions are as follows (check with your accountant for a more detailed review of the rules and related interpretations).
For a capital lease, the equipment is expected to be financed for most of its useful life and there is a reasonable expectation in place that the lessee will purchase the equipment outright from the lessor at the end of the lease term.
An operating lease is basically the opposite in that the equipment is leased for less of the useful life of the asset and at the end of the lease term, the lessee can return the asset to the lessor with no further obligation.
From an accounting point of view, the assessment of capital versus operating lease is done by applying the following four rules to a leasing transaction. If any of these four rules apply, the underlying lease is a capital lease.
First, does the lease term represent more than 75% of the equipments projected useful life?
Second, does the lease provide the lessee with an option to purchase the equipment at an amount less than its fair market value?
Third, will the ownership of the equipment be transferred to the lessee at the expiration of the lease term?
Fourth, is the net present value of all the lease payments greater than 90% of the fair market value of the equipment?
If the answer to all of the four questions is NO, then the lease is an operating lease.
A capital lease ends up being accounted for on your financial statements much like an asset purchase in that the leased item has to be set up as an asset and depreciated over time while the lease needs to be shown as a liability with the interest portion recorded as an expense for tax purposes.
Operating leases are not listed on the balance sheet (they may be listed in the notes) and the related payments are recorded as an operating expense.
Unless the business has no intended future use for an asset after the financing period, the resulting financing tends to be in the form of a capital lease.
Capital leases also tend to be lower in what we’ll call the net effective costs associated with the lease as there is no risk premium built in by the lessor for asset disposition at the end of the lease term.
Operating leases are more suited to assets that either wear out quickly from heavy use or are rapidly replaced in the market by newer technology.
While the typical equipment leasing spectrum tends to cover off virtually any type of asset and almost any level of credit, in Canada, this full range of equipment lease choices is really limited to Ontario.
The size and diversity of the Ontario economy can support a large number of equipment financing companies due to the ability of each lender or lessor to become more specialized on certain asset groups, industry types, credit rates, and even regions within the provincial geography.
To this last point, businesses located in the outlying areas of northern or northwestern Ontario will not be afforded the same financing opportunities as those in the Greater Toronto Area (GTA), but in most cases, they will still have more options than many other parts of the country.
Ontario has a significant number of boutique equipment lenders that are relatively small in size in terms of dollars in their lending portfolios. But collectively, they provide tremendous coverage of all the different possible borrower profiles and equipment types.
And for many asset types, the competition can be significant, providing more choices and options for business owners and managers.
While the size and diversity of the provincial economy drives the overall equipment financing market, there are a few key aspects of a large economy that make it more appealing to lease companies.
First, industry diversity allows a finance company to specialize on the specific asset types in a given sector. This is important to better understand how to value used equipment offered as security and how to liquidate assets to cover off outstanding balances should the need arise.
Larger industries will have active resale markets. For leasing companies, this provides a market for not only disposing of assets on a timely basis, but also creating a secondary market for financing used equipment.
Second, large diverse economies are less impacted, on average, by economic shocks. While the current recessionary impacts are definitely felt in Ontario and across Canada, the Ontario market impacts are always going to be smaller for a number of reasons. 1st, recessionary forces shut down lenders as the money supply becomes constricted. If you’re located outside of Ontario and you lose a key lender that’s available to you, the impacts on your business can be significant if there’s no close alternative. 2nd, a diverse economy will absorb financial shocks better than one focused only on one or two industries.
Third, larger economies tend to offer more sources of capital to lenders. When economic pressures build up, one of the biggest challenges an equipment finance company can have is maintaining sources of capital for their leasing activities. If you’re a leasing company and only have one source of capital that gets impacted by recessionary forces, you can quickly be out of business. While this will also happen to Ontario based equipment leasing sources, it will likely happen less often, and when it does happen, there will be alternative equipment leasing companies ready to step in to gain market share.
The bottom line is that business owner in Ontario may have several equipment financing sources to choose from at any given time.
The key is focusing on relevant lenders that are the most suitable for the equipment you want to finance and the overall financing profile of your business. The best way to get the best results and avoid many of the more typical mistakes, is to work with an equipment financing specialist.
There are numerous reasons to consider equipment lease financing in your business, but for the sake of brevity, we’re only going over the most common reasons we find that business owners and managers utilize equipment leasing.
Deferral of Tax.
When you purchase an asset, you are required to pay the respective sales taxes at time of purchase. With a lease, the leasing company is the owner of the asset at time of purchase, so they pay the sales tax. You pay sales taxes on each lease payment, deferring your tax liability years into the future.
As compared with equipment loans which tend to run around 36 months, equipment leases are more readily available for terms of 5 years and beyond, depending on the asset, age, and condition.
No Down Payment Required.
In many cases, the leasing company will only ask for one or two payments in advance, greatly reducing the drain on cash flow.
True 100% financing
Unlike traditional equipment loan products, most lease programs will allow you to include the costs of installation and freight into the lease financing total, once again saving on your out of pocket costs. The ability to finance these “soft costs” can be the difference between making the capital investment or not.
Because the lease company owns the underlying asset and specializes in financing the asset type, there is considerably less red tape to go through in the application process. And for smaller ticket items, approvals can be accomplished in a matter of hours with very little paper work involved. More support is required for larger purchases, but compared to a traditional bank application the degree of complication and time required pales in comparison.
Conserve on cash.
In addition to the cash saving features mentioned above, most leasing companies will allow you to purchase an asset for cash and then turn around and sell it to the lease company in return for an equipment lease. There may be times when you can get the best deal with a cash purchase. And sometimes a great deal may not be around before you get financing approved. So this sale and lease back process puts cash back in your hands after the transaction has been completed, allowing you to take full advantage of a cash transaction.
In some cases, you may have even had to use your line of credit to buy the asset in the time you had to work with. Similar to the above cash purchase, the acquired asset can be sold to the leasing company in return for an equipment lease with the proceeds from sale being used to bring your line of credit back down and making the funds available for other operational requirements.
If you’d like to get more information on equipment leasing, please give us a call and we’ll get all your questions answered.