If you've ever had to decide whether to purchase or lease vehicles or landscaping equipment, then you've probably come face to face with the complexities of making the right decision.
To test your knowledge of this issue, here is a pop quiz . . .
In a company with less than 20 vehicles is it better to:
A) Lease all the equipment
C) Set up an in-house leasing company
D) Any of the above
In a company with more than 20 vehicles is it better to:
A) Lease all the equipment
C) Set up an in-house leasing company
D) Any of the above
After doing thorough research and consulting with your CPA (Certified Public Accountant), you may be surprised to find the answer is the same for both questions: D) Any of the above. Yes, small companies lease and buy, large companies lease and buy, and extremely large companies lease and buy. All do so very successfully. A better question to ask might be:
A) A science
B) An art
C) A mystery left to your CPA to
D) All of the above
If you answered D) All of the above, then you know what you?re getting into when considering the leasing versus buying issue. Yes, leasing is a bit of a mystery to many people. It is somewhat complex and no written formula can really answer what is right for your business. however, there are certain elements to consider when making your decisions.
A) Leasing As A Science
First of all, to define terms, leasing is a method of paying for the use of equipment or a vehicle over a specified period of time. At the end of that period of time you either buy that equipment or vehicle, or give it back to the leasing company. A closed-ended lease, most common in auto leasing, allows you to simply return the vehicle at the end of the lease period with no other responsibilities. In an open-ended lease, more common in commercial deals, you pay for and keep the vehicle at the end of the lease period.
Leasing is based on the concept that you pay for the amount the vehicle or equipment depreciates during the time you are using it. Depreciation is the difference between the purchase price and its fair market value at the end of a certain period.
For automobile leasing, monthly payments are considerably lower, sometimes as much as 30 to 60 percent below loan purchase payments. The preferred profile for someone leasing automobiles is: You do not put on an excessive number of miles. You want to keep a fairly new car. You drive a conservative car and you keep it in good shape. If your driving habits fit snugly within this framework, then the monthly cost is the obvious deciding factor for your decision.
For commercial leasing, the amount of monthly payments is not the main consideration. Business owners say, in the long run, costs between leasing and buying are very similar, all depending on current interest rates. For example, say you buy a $30,000 truck. At the end of four years you own it. If you lease that truck for four years, payments could be half as much, but at the end of four years you have to pay $15,000 to own it. Leasing may defer costs, but overall it's the same.
Even tax advantages can be nearly the same. Since commercial leases are based on depreciation, monthly lease payments can be very close to monthly vehicle and equipment depreciation. For tax purposes, you either write off the truck as depreciation or write off its monthly lease expenses. Both are not that much different.
A number of landscape company owners, large and small, cite other more important elements to base leasing decisions on.
First is vehicle maintenance. A small company, without its own in-house mechanics and repair shop, will have to take their vehicles to a dealer to repair them. Dealers? hourly rates may run as much as three times higher than the hourly rates you pay your own in-house mechanic. Until your company grows to a size that can support its own repair shop, maintenance costs will be high. Small companies would benefit from leasing and turning their vehicles around after three or four years when maintenance costs start to go up.
The second consideration is capitalization. With leasing there is no 5 to 20 percent down payment needed when acquiring vehicles and equipment. A young company can use that money for working capital. The question to ask yourself is: Can you use that down payment in more effective ways? Would it be put to better use to purchase other equipment or pay other expenses?
Your financial statement is a major element of this decision. If you lease, then the monthly payments go on your company's financial statement as monthly expenses. If you buy, the cost of equipment and vehicles go on the books as a liability. This debt can affect the credit worthiness and bonding value of your company. To be bondable you need a 'quick net worth,' which is your current assets minus current liabilities. With leasing, you can increase your bonding capacity, and with a larger bonding capacity, your company can bid for larger jobs.
Tracking internal company costs is easier with leasing. When equipment is leased, you have a simple monthly check to write. You know what department is using that expense. In purchasing, your books reflect equipment as depreciation, which shows up more like an overhead cost. That overhead does not point out the cost effectiveness of particular equipment in a particular department as an expense does.
John Georgio of Gothic Landscape, with more than four hundred pieces of equipment, likes the ease of tracking costs with leasing. His company buys vehicles and equipment and leases them back to the company. With three locations in Phoenix, Arizona, Las Vegas, Nevada, and Southern California, he is able to pinpoint where costs are going for each location. He has set up his own in-house leasing company for this reason.
For Tom Oyler of U.S. Lawns, it's not a question of leasing versus buying. It's a question of an 18-month lease versus a 24-month lease. Oyler is creating a formula of efficiency for leasing that can be used for many lawn care operations. His evidence so far has led him to believe that short term leases for equipment are the most productive option.
U.S. Lawns is a unique operation. It is the industry's only franchise organization with more than forty companies affiliated, each generating three quarters of a million to two million dollars of revenue annually. To standardize and reduce costs for the franchisees, U.S. Lawns has built what Oyler calls the 'price versus performance' model. They have done cost studies, time motion studies and efficiency research, and have found that it is not the cost of the equipment that matters, but the performance you get for your dollar. Their testing so far has indicated that leasing equipment such as a walk-behind mower for 15 to 18 months proves more productive than buying it cheaply, repairing it and using it for its life of four to five years.
B) Leasing As An Art
Although the leasing versus buying question has structured guidelines, there are many intangibles. Some business owners like to own their vehicles because they like to have control. It is more than just the feel of owning it. They can sell it when they want, modify it, paint it or just use it without having to worry about the leasing company's restrictions. Although heavy restrictions more often apply to auto leasing, it can still be a factor in some commercial vehicle leases. Consider mileage restrictions. With automobile leases if you go over, say, 15,000 miles a year, you have to pay a certain fee per mile. If you went 6,000 miles over, for example, you could pay penalties as high as $1,000.
Here is a very important note of caution. You have to be careful when choosing a leasing agent. You want to find a reputable commercial leasing company. With auto and truck dealers you need to be most careful. They can hide fees, create restrictions, overprice the vehicle and hand over inflated leasing rates that, in the end can cost you plenty of money. If you go to a dealer, be extremely well versed in leasing contracts.
Control of your equipment is not limited to smaller companies who are not sure of what they want.
Rick Randall, of Randall and Blake, who has more than 1600 pieces of rolling equipment, likes to try out equipment for three months to check it out. But, he does it with a short-term lease. He negotiates a three-month lease toward its purchase or a long-term lease. His company may even negotiate a lease for a piece of specialty equipment for just the length of a job, as little as a month or two. In these cases, leasing offers flexibility over purchasing.
Because of the many variables that go into deciding to buy or lease, John Georgio, of Gothic Landscape, points out that there are very successful examples of companies doing both. There are no right or wrong answers. For example, one month Nissan may be teaming up with a leasing company to create very attractive leasing rates. Next month the rates may change leading you to buy. It may make sense to purchase your lawnmowers, but say Chopper Lawnmowers offers a three-year lease with a three-year warranty. Then, especially if you put on excessive hours, it would be more cost effective to lease the mower. In any case, no formula works all the time. It is really what is right for your situation.
In the 'performance versus price' model, says Oyler of U.S. Lawns, we look at the overall performance and cost of equipment. We have determined that the best time to turn over equipment is when the maintenance has moved from the preventive stage to the repair stage. For riding mowers it could be anywhere from 18 to 24 months, and 12 months for 2-cycle equipment. They have not applied this model to vehicles yet.
For franchisees of this size, not small or large, in-house repair shops created problems. Mechanics could be overwhelmed one week and have nothing to do the next. It?s not just the unpredictability of repairs, but also equipment down-time and even the general distraction felt by the employees that lowers performance. Oyler points out that new equipment always features the latest improvements, which help raise production yields. Also, there are the intangibles. Newer equipment tends to raise employee morale. Who doesn't feel good about using the newest and best equipment?
Instead of fighting the manufacturers for the best price, Oyler likes the idea of forming a strategic partnership with them to achieve a common goal. He agrees to a long-term contract with them for equipment needs. They agree to take the equipment back after a short-term usage which they then resell. U.S. Lawns admits they pay a premium price for the equipment, but the extra performance covers that cost and much more.
C) A mystery left to your CPA to unravel
In its simplest terms, leasing is just another method of financing. Larger companies say there is no significant tax advantages or cost difference between the two. One reason for this is because larger companies with solid credit and buying power can command very good leasing rates and purchase prices. But the same is not necessarily true for smaller companies, and here is where only your accountant knows the answer. Not much can be said here about the complexities of accounting. It is your accountant?s specialty to make sense of these finer points. But, just to mention one point: tax benefits for purchasing may differ significantly from corporations to privately-owned companies, all depending on the person?s individual tax rate. Let your accountant work this out.
D) All of the Above
Leasing is a complex issue. One of the biggest mistakes you can make is to think it is simple and skip doing the necessary research. Everyone educated about this subject stresses the importance of gaining the knowledge. As costs rise and competition increases, it's important to make the right decision.
As the quiz states, leasing is 'all of the above.' It is a science, an art and a mystery for your accountant to unravel. Gaining the knowledge of these complexities is the first step in making the right decision that will help your company become more effective and competitive.