Having the right tools, technology, and machinery is essential for growing your business, but meeting these needs shouldn’t drain your cash reserves. In fact, 82% of American companies use some type of financing when acquiring equipment, according to the Equipment Leasing & Financing Association. This includes loans, leases, and lines of credit (but not credit cards).
The classic crossroads for small business owners is the choice between an equipment loan vs an equipment lease. Is it better to buy the equipment using a small business equipment loan or choose equipment leasing for a set period? There isn’t any one-size-fits-all answer here. It really depends on your cash flow, your industry’s pace of innovation, and your long-term financial goals. The pros and cons of buying vs leasing equipment involve its useful lifespan, the impact either option could have on your cash flow, and the tax strategy of your business.
When to Buy (Finance) Business Equipment
For most small businesses, when they buy equipment they typically do so through a customized equipment loan. One of the main benefits of commercial equipment financing is that you’ll own the asset once the loan is paid off, which allows you to build equity. For companies that choose this option, they typically do so with equipment that has a long lifespan and won’t become obsolete by the time the loan is paid off. Examples of this include heavy construction machinery, office furniture, commercial vehicles, and manufacturing gear. Another reason is the business wants to add a tangible asset to its balance sheet, which gives it collateral that can help it secure other loans.
There are also tax advantages because you could make use of depreciation write-offs, such as Section 179 tax deductions. It applies to tangible business property such as machinery and equipment that’s purchased for use in a trade or business, as well as office furniture, computers, and off-the-shelf software. It may also include “qualified real property,” such as improvements to roofs, HVAC systems, fire alarms, and security systems, for nonresidential real property.
When to Lease Business Equipment
Leasing equipment is essentially renting it for a predetermined term. One of the main benefits of leasing business equipment is that it usually involves lower monthly payments than you would see with a business equipment loan. Leases are typically used when buying equipment that faces rapid obsolescence and needs frequent upgrades to remain competitive, such as information technology (IT) hardware, specialized medical devices, and cutting-edge software systems.
Another reason to choose an equipment lease is that it preserves working capital and lets you keep more of your liquid cash on hand to fund your operations, make payroll, and cover unexpected expenses. Many lease agreements also include maintenance and repair coverage, which can help you avoid financial surprises. Perhaps the biggest downside to leasing equipment is that you don’t build equity, and leasing can sometimes be more expensive than buying through an equipment loan.
With an equipment lease you can’t deduct for equipment depreciation on your taxes, but you could deduct your lease payments and interest costs as long as the contract involves an equipment lease and not a conditional sales contract. If you’re acquiring equipment through a conditional sales contract and you’ll wind up buying the equipment, you could deduct your depreciation expenses instead.
Key Factors to Base Your Decision On
When it comes to the choice between leasing vs buying business equipment, there are several things to consider. You might start by analyzing your cash flow and figuring out how much capital you can allocate without putting your operations and financial liquidity at risk. We also recommend considering the lifecycle of the equipment you need and how long it will meet your business needs before it has to be replaced.
For many business owners the shorter the lifespan of the equipment, the more likely they are to lease something to avoid paying off a loan on something that became functionally obsolete. The longer the lifespan, the more likely a business is to pursue equipment financing. Of course, your tax strategy also has a role in this. Your bottom line may come down to whether it’s better to deduct your lease payments as a business expense or claim depreciation on purchased assets. Your accountant or tax advisor could help you figure out which benefit works best for your business.
Another thing to consider is what may happen if you have to terminate a lease ahead of schedule. Depending on your contract, this would likely result in financial penalties which may require you to cover all remaining lease payments along with an early termination fee. This is typically set according to a sliding scale based on how much time you have left in your lease, although the fee could be as high as 10% or more.
Business equipment loans could have prepayment penalties if you pay off the loan ahead of schedule. Penalties are typically set according to a sliding scale based on how much time you have left in your repayment schedule and would typically be anywhere from 1% to 5% of your remaining loan balance.
Why Partner with ABC Bank for Your Equipment Needs?
There’s a huge difference between big national banks and local institutions, especially for small businesses. National banks typically have rigid lending criteria and a one-size-fits-all approach where you either fit in a box or you don’t. They’re also known for hidden fees and having a slow, corporate bureaucracy where your business is just an account number and the lending decisions are made by someone in an office tower in another state, who lacks insight into our local market and economy.
With ABC Bank, all our lending decisions are made locally, either in Texas or Colorado, by people who have deep ties to the community. This reduces some of the “red tape” of larger banks, ensuring faster approvals and agile financing. You also gain access to a dedicated team of local experts who understand the unique dynamics of our regions. Read more about [Why A Local Bank Could Be Your Business’s Best Financial Partner].
We offer tailored equipment loans with flexible terms to match your business’s cash flow and growth cycles, and a dedication to having a positive impact on the community. By growing your business with ABC Bank, you’re working with a partner that empowers and supports your community.
How to Finance Business Equipment
Leasing is a smart move for fast-changing technology and equipment with shorter lifespans, while equipment loans are ideal for long-term operational investments. Fortunately, you don’t have to navigate this financing maze alone. Reach out to our commercial lending team at ABC Bank or visit one of our branches in Texas (Austin, Dallas, Plano, Lubbock, Wolfforth) or Colorado (Pueblo, Colorado Springs).
