Equipment finance can be traced back more than 4,000 years, when Sumerians produced leases on tablets made of clay (not Apple) for agricultural tools and animals. Today, the industry meets the equipment needs of not just agri companies, but the construction, transportation, medical and manufacturing industries, just to name a few.
According to the Equipment Leasing & Finance Association (ELFA), equipment leasing and finance is a $1.2 trillion industry that continues to grow. Additionally, ELFA statistics show 80% of all businesses purchase some type of equipment each year. This could vary from heavy machinery to technology to office furniture and fixtures.
All can be financed using various structures and products.
A major challenge for businesses is how to pay for necessary capital expenditures. Traditional loans are very common, but one structure that often gets overlooked is leasing.
If a company can use its own cash and not incur debt, of course, that is the best solution. However, most companies prefer to hold on to cash reserves and finance all or a portion of their purchases. Equipment leasing allows the company to maintain its cash with 100% financing, along with some flexible end-of-lease options and possibly lower monthly payments.
For example, an equipment purchase totaling $100,000 with a 5.5% interest rate would have a monthly payment of $1,910. However, that same equipment on a lease structure could have a monthly payment as low as $1,500. How is that possible? Leases contain a residual that is due at the end of the term and can vary from a few dollars to more than 20% of the purchase price.
In 2018, the Federal Reserve increased the fed funds rate four times. That is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. There are mixed signals on what the rates will do for the rest of 2019. If rates continue to increase, then a lease structure could make more sense for your business. This would allow companies to finance their equipment purchase while not committing to the residual payment until the end of the term, if at all. In a rising rate environment, leasing structures may be the lowest payment option for you.
There are many options for the residual payment at the end of the term that can be discussed and agreed upon prior to equipment purchase. The most common in an operating lease structure is a “walk away” option the customer isn’t obligated to pay. The equipment would be returned in an agreed upon condition and location to allow the finance company to sell. The customer also would have the option to pay the residual and purchase the equipment outright.
The leasing industry is known to have flexible payment options to meet the customer’s needs and is another benefit of this type of finance structure. The form of payments range from seasonal for retailers and agriculture to deferred, upfront payments in the medical industry. Matching the payment structure to accommodate the customer’s cash flow is a good example of knowing the customer and finding a solution that works for both parties.
Another benefit to equipment leasing involves equipment obsolescence. Leases are typically structured to limit the maximum term to no more than 80% of the asset’s useful life. That allows the customer to upgrade their equipment before it becomes obsolete and take advantage of the latest technology available.
Over the years, I’ve seen companies lease equipment for many reasons: to conserve working capital, preserve bank lines, overcome budget restrictions, hedge against equipment obsolescence, accounting advantages, etc. In addition to the lower payments, there also could be tax benefits with lease structures. Because tax rules change frequently, it’s always best to consult with your tax adviser before entering into a lease arrangement.
Next time your company is considering financing equipment, take the time to explore what leasing options are available, and I think you will be surprised.
Editor’s note: Eric Bunnell is a Certified Lease & Finance Professional (CLFP) and president for Arvest Equipment Finance, a division of Arvest Bank, in Fort Smith. He can be reached at 479-573-1651. The opinions expressed are those of the author.