Should Your Small Business Buy or Lease Equipment?
Every small business owner eventually faces it: The business needs to add a new piece of equipment or replace an old or broken one. Maybe it’s a commercial vehicle or a diagnostic machine. Maybe it’s a piece of manufacturing equipment or a high-end copier. Whatever the item, the sticker price is considerable, and the pressure is real.
And the question “Should my small business buy or lease this equipment?” turns out to be more complicated than it looks. That’s because there’s no universal correct answer.
The better question is: Which option is right for your business right now?
What Buying Means for Your Business
Purchasing equipment outright, or financing it through a loan, means you own the asset. And when you own equipment outright, you stop paying for it once the purchase price (plus any loan interest) has been covered.
A couple of financial considerations to be aware of:
- A purchased asset appears under fixed assets on your balance sheet. It’s offset by any corresponding loan liability. Over time, you depreciate the asset, gradually reducing its book value.
- Under Section 179, businesses can deduct the full purchase price of qualifying equipment in the year it’s placed in service, up to annual limits set by the IRS, rather than spreading deductions across the asset’s useful life. Bonus depreciation is also an option, though businesses should understand that using this on one asset requires you to take bonus depreciation on all other assets within that asset class.
Broadly speaking, buying tends to make the most sense when the equipment has a long useful life, holds its value reasonably well, will be used heavily and doesn’t need to be upgraded frequently. A construction company purchasing excavation equipment it’ll run for a decade is a very different scenario than a medical practice considering imaging technology that could be obsolete in five years.
The downside: Buying ties up capital or creates debt. For cash-constrained businesses, a large outright purchase can limit your operational flexibility in ways that ripple through the rest of your finances.
What Leasing Means for Your Business
Leasing is paying for the use of an asset over a defined period. You don’t own the asset, you’re renting it.
There are two types of leases you need to know about:
- An operating lease is what you think of when you think of a traditional rental: You use the equipment for as long as you pay the lease. You do not end up owning the equipment. These are traditionally shorter-term arrangements with high flexibility. As long as the lease term is shorter than 12 months, the asset does not go on the balance sheet; operating leases longer than 12 months are reported on the balance sheet. Lease payments are typically 100% deductible.
- A finance lease (sometimes called a capital lease) is a pathway to eventual ownership. These are usually much longer-term leases, making it costlier to end the lease agreement early. The business may be responsible for repair, maintenance and operating costs. At the end of the lease, you may have one or more of several options, including buying the equipment at fair market value, buying the equipment for an amount determined when the contract was originally signed, renewing the lease or returning the asset.
Leasing tends to make the most sense when you need to preserve cash flow, when the equipment has a short technological shelf life or when you need flexibility to upgrade or exit at the end of a term. It also simplifies the disposal question: When the lease is up, you hand it back rather than managing a sale.
The trade-off is total cost. Over the long run, leasing the same piece of equipment typically costs more than buying it outright. You’re paying for flexibility, and that premium is real.
The Financial Statement Impact
The buy-vs.-lease decision shapes how your business looks on paper, which matters if you’re seeking financing, bringing in investors or working with a bank.
Purchased equipment increases your total assets and, if financed, your total liabilities. That changes key ratios lenders examine, including your debt-to-equity ratio. Depreciation also reduces net income each year, which can lower your taxable income but also make profitability look softer on paper.
Short-term operating leases, by contrast, keep leverage metrics cleaner. Assets and liabilities stay off the balance sheet, and the income statement shows a straightforward periodic expense. Finance leases, however, behave more like debt and will affect your leverage ratios similarly to a loan.
If you’re planning to apply for a line of credit or seek outside capital in the next few years, it’s worth thinking through how each option affects the financial picture a lender will see.
Questions Worth Asking Before You Decide
Before signing anything, ask yourself these questions about the asset being considered:
- How long will you realistically use this equipment?
- How quickly does this technology change?
- Do you have the cash reserves or credit capacity to buy the asset without straining operations?
- Is maximizing a current-year tax deduction a priority or is cash flow preservation more important?
- How does this acquisition affect your balance sheet?
Ready to Make the Right Equipment Decision for Your Business?
Whether you’re weighing a major purchase or evaluating a lease agreement, the financial and tax implications deserve a careful look before you sign. The right choice today can save you real money and the wrong one can create headaches you didn’t see coming.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm that serves small and midsize businesses. Our experienced consulting team can help you think through equipment decisions, assess the impact on your financial statements and tax returns, and make sure you’re positioned to move forward with confidence.
Call us at 440.892.8900 or contact us online to learn how we can help you make smart financial decisions for your business.
Tags: McManamon, small business | Posted in McManamon & Co., small business, Small business finances