Understanding Financing Alternatives

• Purchase from Operating Capital
• Borrow against Credit Lines
• Finance Lease
• Operating Lease

Purchase from Operating Capital

Benefits -

• No Incurrence of Debt -- Good for the balance sheet.
• Ownership = Control -- You can get rid of the equipment when you want; sell it; move it; trash it.

Burdens -

• Drain on Funds -- Can you use your capital at a better rate of return than you pay under a lease or other financing?
• Expense without full tax benefit -- Since you can only depreciate the equipment over a limited number of years, you incur all the expense up front, but can deduct only a fraction of the expense each year.
• Risk of Obsolescence -- You plan to sell your computers in three years and upgrade; but they become nearly worthless. Now you have a book value (the original cost less accumulated depreciation) that is significantly greater than the market value of the equipment, resulting in a loss on your books.

Borrow against Credit Lines

Benefits -

• No Cash Drain -- Keep your cash in your business or invested where you want it.
• Predictable Cash Flow -- If you have fixed rate financing, you end up with a fixed monthly cost.
• Ownership = Control.

Burdens -

• Incurrence of Debt -- You may like to say you have a "debt-free" business.
• Ties up Existing Credit Facility -- Why use it if there are alternatives. Save it for working capital needs.
• Risk of Obsolescence.
• Unfavorable Balance Sheet Treatment -- Debt on your balance sheet in the full amount of the cost.

Finance Lease

Benefits -

• No Cash Drain.
• Predictable Cash Flow.
• Control at Lease End -- At the end of the Lease, you are the owner (usually through a $1 buyout).
• New Capital Sources -- You're not using your existing credit facility. The leasing company provides a new source of funds; probably one which you would not have access to.
• Complete Project Financing -- Can cover soft costs (e.g., software, consulting, installation, training) and hardware.

Burdens -

• Incurrence of Debt.
• Risk of Obsolescence.
• Unfavorable Balance Sheet Treatment.

Operating Lease

Benefits -

• No Cash Drain.
• Lower Cost -- Since the lessor invests in the equipment, the rental payments over the lease term cover less than the full cost of the equipment. Effective rates over the lease term may be several points less than the Prime Rate!
• Predictable Cash Flow.
• New Capital Sources.
• Complete Project Financing.
• Flexibility -- You can work with your lessor to upgrade or expand at any time, focusing on your budgetary limitations. For example you might add new equipment but keep the rental the same by extending the term; or you might pay $0 per month until next year when your new budget kicks in.
• Operating Expense -- The monthly payment is fully expensible for accounting purposes, and fully deductible for tax purposes. The rent for the year is charged as an operating expense against income in your P&L. There is no debt reflected on your balance sheet.

Burdens -

• Firm Term Lease -- You are committing to a firm term , so you cannot terminate at any time.
• No Tax "benefits" of Ownership -- You do not depreciate the equipment on your books, the lessor does. However, you get a faster "write off" of the cost since all payments over the term are expense items.