Buying vs Leasing free essay sample

What would be the best option for a company to lease or purchase equipment? Each business owner’s situation is different. The decision to buy or lease business equipment is unique. It must be made on a case-by-case basis. Leasing equipment preserves capital giving the business more flexibility. While leasing can be good in the short run it can cost you more in the long run. We will look at the advantages and disadvantages of leasing. My research will look at the different options a company faces if they lease or buy and why it has become more attractive to lease. First let’s start by describing the basic concept of a lease. Some leases are merely rentals, whereas others are effectively purchases. FASB classifieds lease as an operating lease or a capital lease. A lease must meet one of the following criteria’s to be considering a capital lease. The lease is greater than 75% of the property’s estimated economic life, the lease contains an option to purchase the property for less than fair market value usually at a bargain price, ownership of the property is transferred to the lessee at the end of the lease term, or the present value of the lease payments exceeds 90% on the fair market value of the property. The lessor transfers the right to use the property to a lessee. Lessor is the finance company and lessee is the person leasing. The lessee makes one-time or periodic payments to the lessor in return for the use of the property. Leased asset can either be tangible property such as a home, office, car, airplane or computer. If you run a business and have to decide to lease or buy here are some benefits of leasing to consider. Less cash up front means conserving capital. A lease can also provide services to the equipment by giving it maintenance. Lease payment terms tend to be longer which makes payment more attractable. The ability to upgrade equipment is a benefit in growing businesses that need to keep up with technology. One advantage of leasing business equipment is that it allows you to acquire assets with minimal down payment or no down payment at all. This is good to your cash flow. The more cash your company shows and has makes it more attractive to its investors. Lessor has certain roles, they are customers to the manufacturers, and they are customers offering a crucial distribution. Leasing equipment provides he lessee with all the following benefits utilizing the equipment without having to pay the up-front costs or assuming the risk of ownership. A lease is one of the best ways for businesses to stay on top of the development curve. With so many new developments that occur specially in technology areas equipment leasing is less financially expensive. To the airlines they are a more affordable method of supplying what they need. While there continues to be turmoil in the financial markets commercial lenders focus premier on credits and a lot of the airlines won’t qualify to buy an airplanes. That is why leasing has become popular among the airline. The airlines are coming to the conclusion that it might be better for someone else to own the assets. Let’s take into consideration why airlines would lease its commercial jets. When making the decision to buy or to lease the company must consider financial implications and options including the value of the money. Operating leases are for terms shorter than expected life of the aircraft, and the asset typically need not appear on the balance sheet. A capital finance lease covers the useful life of the aircraft. A sale-leaseback arrangement involves purchase of the aircraft and use for a short period of time, followed by sale to the lessor who then leases the aircraft back. Airlines are more increasingly turning to operating leases to bear the risk of a slump. American Airlines is one example of having the flexibility of going bankrupt and tear up leases and return the planes back. While it makes sense for airlines to rent airplanes the case can be made in the opposite direction. Airlines can also be better off buying planes and keeping them for their full lifespan of 30 years or so. Like house, then, buying is cheaper than renting in the long term. While leasing has both advantages and disadvantages. Let’s take a look at the disadvantages. The lack of ownership would be a main disadvantage. You are obligated to make payments and when a lessee encounters financial distress, the lessor typically becomes its largest creditor. If a lessor decides to reduce exposure and recall its leased aircraft, an airline can no longer operate. Lessors require payments for all aspects of airplane utilization and rent, meaning maintenance reserves and so on. The cash flow becomes much tighter while if they own their own jets they have much more flexibility. According to Boeings Zolotusky, it comes down to two basic considerations, the quality of the aircraft involved and the customer involved. Businesses can change operations and it may be expensive and difficult to terminate a lease before the end of the term. If the business owns the property it might be easier to sell and make money rather than losing all of its assets and getting nothing in return. In some cases of leasing when it’s time to renew the owners might demand higher rental payments putting the lessee at a disadvantage. Lessors offer a very sensible business proposition. For airlines that want to be primarily airlines, it’s a very attractive and efficient service. If the operators want to focus on the service of getting people on planes, they don’t want to focus on the business of asset ownership and management. Most states charge substantial sales or use tax on the purchase of or use of an aircraft’s. However in the case of leasing the aircraft the tax can be avoided entirely. An aircraft leasing company can create a win-win situation for both the aircraft investor and the State. The rules are good for the state because the state charge sales tax on interest payments, which would not be taxable. The tax deferral can have permanent benefits where as is often the case, the investor only holds the aircraft for a few years. However, if the investor uses a leasing company, the tax cost will be unchanged. The other advantage to using an aircraft leasing company is the resale exemption to purchase parts and labor tax-free. It would also reduce the risk of other states imposing a tax. Using the aircraft leasing company will not generate any negative FAA and income tax consequences. Income tax consequences can me more complex because of the special rules that apply to leasing companies, including the passive activity loss rules. One way to avoid this problem is by a leasing company which is a single member LLC owned by the user. The single user is ignored for tax purposes and treated as a separate company for sales tax purposes. However it may not be the case for all States. In conclusion aircraft leasing can save companies thousands of sales tax dollars. Being an owner of an aircraft can give you the right to depreciate it for tax purposes but only the interest, no principal will be deductible. While for some companies facing potential alternative minimum tax issues, a lease payment would fully be deductible. Lessors assume a residual value to the aircraft being leased; they can typically offer a lower rental payment. However to optimize the cash flow benefit, leases usually must be for a longer term. It not only allows more cash in your pocket but it can also your lines of credit open. Leasing can remove long-term debt from the balance sheet. Many lease agreements qualify as an expense, no debt. Companies like this because it makes the balance sheet seem more attractive. In the end I think airlines have fewer cost if they lease rather than buying their commercial jets. Leasing can also take away the financial burden of buying them and to provide temporary increase in capacity. My findings let me to the conclusion that leasing can be a better option for business owners. Owners can have more capital and grow more rapidly by leasing. While leasing businesses are generating revenue by benefiting from equipment. Lease payments are considered expenses rather than assets, which can offset revenue when calculating taxable profit at the end of the tax period. In the airlines case if they wish to grow they have more flexibility by leasing the aircrafts. Also, a company with international operations may have options, in terms of structuring the acquisition, that make the option of leasing more desirable option. Since the leases for aircraft typically offer a lower rental payment it can increase the airlines cash flow. Leasing can also help the airlines by keeping their credit open making it easier to borrow. Its relative easier to lease in the credit market than buy using the credit. A lot of airlines file for Chapter 11 and don’t have sufficient credit to borrow later on. Leasing gives them an option. In my opinion leasing is best option and offer many financial benefits. Your business can grow by leasing. It can help businesses safeguard cash flow by paying for equipment as it generates revenue. If the equipment gets outdated leasing gives businesses the option of updating it. Depreciation also is a major consideration. For assets that depreciate rapid due to wear and tear or through becoming obsolete leasing can prevent significant loss on value. Leasing could permit the use of the equipment while it’s new and then on completion of lease it can be updated or returned. Maintenance is also another advantage. Lessors try to give best maintenance since they are still the owners of the property. Leasing provides the flexibility to businesses that want to grow. It is why I conclude that leasing is the best choice in this competitive market place where technology is constantly changing and businesses must keep up with improvements to stay competitive. References Earl K. Stice, PhD: Intermediate Accounting:2010,2007 South-Western ,Cengage Learning The Economist Newspaper: The Economist, 2012,Buy or Rent? Pam Newman: Entrepreneur :2006 Leasing Vs Buying: Which is Best for You?