Business Leasing

Leasing is an equipment financing option that is sometimes overlooked by business owners. It provides an excellent combination of cash flow flexibility, potential tax benefits, and protection against technological obsolescence. There are numerous leasing arrangements that can be entered into, and numerous leasing organizations. We have listed a few of the more common types of business leases:

Finance Lease (Conditional Sale)

The finance lease combines some of the benefits of leasing with those of ownership. Payments are spread over a period of several years and often represent the full value of the equipment.

The advantage of a finance lease is that you have the opportunity to own the equipment at the end of the lease, generally for a minimal payment or for a small percentage of the original equipment cost.

True Lease (Tax Lease)

Under a true lease, the lessor is the legal owner of the equipment. For that reason, this type of arrangement can be particularly attractive for companies and professional practices acquiring equipment that is vulnerable to technological obsolescence, such as computers. A true lease gives you a lower monthly payment for a given piece of equipment than a finance lease would, and in some cases, your business can claim the lease payments as tax deductions. You have three options at the end of the lease term. You may purchase the equipment for its fair market value, continue to lease it, or return the equipment to the lessor.

Operating Lease

An operating lease is generally for a short term (typically three years or less) and is often used with high-tech or other obsolescence-prone equipment. In this type of lease, the lessor typically takes a significant residual position in the lease pricing, thereby bearing more of the risk of ownership. This, in turn, allows a lower monthly payment for the lessee. Operating leases may qualify for "off balance sheet" financing for the lessee, in that the lease is recorded neither as an asset nor as a liability. In addition, the lessee has no further obligation with respect to the equipment once the conditions of the lease have been fulfilled. As with a tax lease, the lessee usually is given the option to purchase the equipment at fair market value.

Skip Lease

A skip lease has a repayment schedule that includes months when no payments are made (and no penalty is assessed). Ideal candidates for this type of lease are organizations that need a flexible repayment schedule such as seasonal businesses (agricultural or recreational services firms, for instance) and school systems.

Deferred Lease

A 60- or 90-day deferred lease can be structured as a finance lease or a true lease. There is usually no advance payment required, and the first payment is not due until the second (60-day) or third (90-day) month of the lease. This structure is useful for businesses that acquire income-producing equipment that takes a few months to begin generating revenue.

Pre-Paid Purchase Option:

This type of financing enables you to significantly reduce your monthly payments by pre-paying a percentage (10%, 15%, or 20%) of the equipment cost.

Factoring

Companies who cannot afford to have their cash flow tied up in receivables for longer than 30 days may opt to factor their receivables. Factoring allows companies to receive cash for their receivables before those invoices are collected. Under a factoring agreement, the Factor purchases a company's receivables at a discount (e.g. 80 cents on the dollar) and normally without recourse. The Factor then assumes the credit risk for collecting those accounts. The advantage to the company is that it receives its working capital more quickly and does not have to deal with chasing unpaid invoices.

The Factor assesses the credit worthiness of the company's customers (not the company itself) and assigns a price to the receivables accordingly. The company then assigns the receivables to the factor in return for a single payment and the customers' payments go directly to the Factor. An on-going factoring agreement allows for greater control over receivables and cash flow, because payment of receivables purchased by the factor is contractually guaranteed and is made on a scheduled basis.

Small companies without a credit history or that are highly seasonal can benefit from factoring. Factoring often allows such companies to maintain liquidity and avoid credit problems with their customers. Factoring is also a matter of convenience for small companies who do not have the resources to pursue bad debts.

Factoring can actually help a company increase its sales. Having capital tied up in receivables hinders a company from aggressively pursuing new sales. Smaller companies often cannot afford to deal with customers who pay their bills much later than thirty days after invoice. These companies may be forced to refuse profitable orders because their working capital is tied up with slow-paying customers. Because factoring gives the company greater control over cash flows, it does not live under the threat of a working capital crisis instigated by slow-paying customers.

While factoring is a valid source of financing for certain businesses, it is generally more expensive than traditional forms of borrowing. However, when short term financing such as a revolving line of credit is not obtainable, factoring is an important tool.