Why Lease if You Have High Cash Reserves?
March 2, 2020
The affordability of equipment, technology and other hard assets can make or break a company’s growth. This is why leasing is so appealing to many businesses – acquiring these necessary items with a manageable monthly payment. But why then do established businesses with large cash reserves choose to lease, when they could just pay off the asset and avoid the interest? It turns out that there are quite a few benefits to financing for all types of organizations, from start-ups to Fortune 100s alike.
Leasing allows your customers to deduct monthly lease payments on a true lease as an operating expense. Depending on the lease structure and the accounting treatment, this means their lease may qualify for off-balance sheet treatment, which may assist them in acquiring the equipment they need while maintaining compliance with bank and loan covenants, staying within capital budget constraints, improving their financial position.
Another set of tax benefits many organizations take advantages of are Section 179, bonus depreciation and qualified leasehold improvements. With Section 179, the IRS allows for the project cost to be fully deductible if your business uses the leased equipment and lease payments pay the cost over time. Interest as part of the payments is also deductible.
Bonus depreciation is the provision that allows businesses to expense off a portion of an asset in the year it is added. This has proven to be very helpful for businesses with large amounts of qualifying equipment, as they are able to save large amounts of tax in the year of purchase. With a gradual depreciation phase-down in place, production equipment and improvement purchases with less than 20 year lives will be able to be expensed at 50% of the asset price in the year of purchase through 2017, 40% in 2018, and 30% in 2019.
Qualified leasehold improvements allow depreciation lives to be reduced to 15 years, instead of the 39 year schedules normally applied. This means that after Section 179 and bonus depreciation deductions, a business will be able to accelerate remaining tax value of improvements over 15 years instead of 39 years. This rapidly reduces the timeframe in which a business can depreciate an asset and enjoy the tax benefits more quickly.
Cash on Hand
It is hard to think of a scenario in which a business having a solid cash reserve would be a bad thing. As any business owner will attest to, having liquid capital to fall back on is always a good idea, especially when one considers the multitude of issues that may arise in a given day. While many businesses have the ability to pay for the equipment and other hard assets up-front, they would rather not deplete their cash or working capital capabilities. And with the ability to put little to no money down in order to acquire an asset, businesses are able to continue their workflow without disruption from an extended waiting period.
Fixed Monthly Payment
Knowing that a fixed cost is on the horizon can actually be a relief to a business. One of the most difficult things about expense accounting month-to-month is factoring in the new, surprise costs that pop-up. That is why even when they are able to pay the full cost up-front, many businesses opt for monthly payments since they are expected costs that allow them to better manage their budgeting cycle.
Hedge of Technology
In an age when the next best thing may be available a month after you purchase the latest and greatest, there can be a fine line behind staying up to date and lagging far behind. This is one benefit that leasing can provide better than paying for assets outright. Depending on the structure of the financing agreement, many companies lease assets as a way to stay current with advancement, updates and new features on a regular basis. This usually proves easier than trying to sell the asset themselves at a loss, only have to turn around and buy something new at full-price.
Since leasing is a hedge against technology, many businesses choose operating leases wherein at the end of the lease term, they have the option to return the asset. If the then fair market value of the asset is less than the residual that the business assumed, they bear the loss but are protected from fair market value fluctuations. Also, if the lessee chooses to swap the asset for one of newer technology, then the existing lease can typically be terminated, and a new lease initiated.