The Federal Reserve’s incremental adjustments to interest rates in the past year have manufacturers reconsidering how to address capital investment needs. Multiple factors can affect whether a company chooses to lease or buy – the return on investment, cash flows, and the productive life of the asset. Generally, the cost of capital is at the top of the list. The low cost of borrowing money over the past ten years tipped the scale toward choosing to borrow and purchase, rather than lease equipment. However, with the prime rate now at 5.0, the choice has become a little murkier. Locking in a borrowing rate now for anticipated purchases over the next year is one short-term solution for which there is generally a premium attached. Even under circumstances where a business has the cash to make capital purchases outright, it may still make better business sense to consider fair market value (FMV) leasing.
There are a variety of benefits of FMV leasing in today’s market:
- Avoiding the burden of asset obsolescence: This benefit is most apparent when considering purchases of technology and software. Life cycles for these assets typically fall within a 3-year range, which generally coincides with their leasing periods. Upgrades are a natural progression in a leasing program, and in some cases, can be made before leases expire, depending on the agreement.
- Improved cash flow and liquidity: While the purchase of a capital asset requires payment or a significant down-payments and fees upon delivery, lease payments typically begin after the equipment is operational. Without committing to a significant cash outlay, the company can direct cash towards investments in its business versus its infrastructure.
- Flexibility: Generally, the lessee has options to purchase some or all leased equipment at termination; therefore, taking the risk out of committing to a purchase at the onset. Leased assets are quicker to obtain and tend to be more flexible than equipment loans giving a business the perspective that time brings into the final decision.
GAAP’s new lease accounting standards, Accounting Standards Update (ASU) 2016-02, have added a new metric, further blurring the lines between owned and leased assets from an accounting perspective. The standards, effective by 2020, re-characterize leasing arrangements whereby a lessee’s contractual access to leased property represents an asset, and the related future obligation to pay for that right is debt. Owned and leased assets will basically tell lenders and vendors the same story about your business; removing the advantage of one over the other from a business reporting stance. (See more about ASU 2016-02 at DiSanto, Priest & Co.’s blog, THE NEW LEASE ACCOUNTING RULES – JANUARY 2020 IS NOT THAT FAR AWAY).
If you’d like to discuss a strategy that would best suit your company’s capital investment needs, please contact us.