Heavy equipment and machinery are the lifeblood of the construction industry. Construction business owners need the latest cutting-edge equipment to gain a competitive advantage over business rivals. However, you may not always have the cash to buy the equipment you need outright.
Cash flow is a big issue in construction due to the nature of the payment and billing cycle. From securing lien rights and filing mechanics liens to tapping into financing options, businesses must be savvy in managing money. The same savviness is required when you’re looking to get the latest equipment.
The decision to go with either equipment leasing or financing involves a lot of consideration. Businesses should consider the type of equipment needed, how often the equipment will be used, the cost of maintenance and repair, and the resale value. Both leasing and financing can help you acquire the necessary equipment, but each has its own advantages and disadvantages.
So which option makes sense for your business? Here’s a useful guide to equipment leasing versus equipment financing.
Equipment leasing or equipment financing?
Equipment leasing refers to renting a piece of equipment from a lender for a specific period of time. In exchange, the lender receives monthly payments for the duration of the lease. At the end of the lease, the company has three options: return the equipment, renew the lease, or purchase the equipment.
On the other hand, equipment financing refers to borrowing money from a lender to purchase a piece of equipment. The financing company can loan you all, or most, of the entire cost of equipment, depending on the type of equipment. You need to pay the loan and interest based on your payment terms with the equipment acting as collateral.
The major difference between equipment leasing and equipment financing is ownership. With equipment leasing, you don’t own the equipment outright, unless you have the option to purchase it at the end of the lease agreement. With equipment financing, you will fully own the equipment after paying off your loan.
Pros and cons of equipment leasing
If you are considering a piece of equipment that is at risk of being outdated in the future, consider using an equipment lease. Equipment lease terms are usually between two to seven years, but the duration will not outlast the equipment’s useful life.
The best business benefit of leasing equipment is access to a higher standard of equipment which could be too expensive for you if you chose to but outright. Aside from this, one of the biggest advantages of equipment leasing is flexibility. It is easy to negotiate the lease term and payment structure to have one that works for your business. Aside from the option to renew the lease or purchase the equipment at present value, some equipment leases may let you trade the equipment for an updated one. This option lets you maintain your competitive advantage without worrying about the equipment becoming obsolete.
Asset management is also easier with an equipment lease. With leasing, there is no transfer of ownership. You are responsible only for the time you use it, and most of the time, the lessor has the responsibility to maintain the asset and dispose of it at the end of its useful life.
However, equipment leasing is not without disadvantages. It usually has a higher total cost compared to an equipment loan, so many businesses who opt for equipment financing will end up paying less overall. The lessor also includes an effective interest rate on your monthly payments to earn a profit.
In addition, the number of equipment available for a lease may be limited, so it's worth bearing this in mind if you need specialist equipment, as you may have to settle for different equipment than what you wanted. Finally, the lessor may restrict the usage of the equipment, so be sure to check terms carefully.
Pros and cons of equipment financing
Equipment financing is the best option for durable, long-term equipment. If your equipment loan application is approved, the lender will front you between 80% to 100% of the entire cost of the equipment. The length of the loan depends on how long the lender thinks the equipment will be valuable.
Equipment financing typically has an easier qualification process. Even if your company does not have a great credit history, most equipment lenders are happy to consider you for a loan. You may still be qualified for the loan because the equipment acts as collateral. This means that if you default on your loan payment, the equipment loan provider can simply seize the equipment they are financing, liquidate it, and recoup the money they lost. This lowers the risk that the lender shoulders if a borrower fails to pay. As such, they tend to be less strict about a borrower’s annual income and credit history compared to other types of loans.
What equipment loan lenders focus on is the condition and resale value of the equipment you plan to purchase. The resale value is a huge factor in how much a lender is willing to extend to you. The higher the resale value is, the more money they will be more willing to lend.
In addition, the total cost of an equipment loan is usually lower than a lease. There will be interest, but financing has lower interest rates compared to other short-term loans. You may also be eligible for tax benefits if you use equipment financing.
Unlike equipment leases, equipment financing usually requires an initial down payment. This can be a challenge if you have cash flow issues. Furthermore, full ownership of the equipment means you are at risk of owning obsolete equipment. That is why it is advised to only use financing for equipment that will not be outdated quickly.
When it comes to leasing versus financing, evaluate your goals closely and choose the solution that will work best for your business and its needs.
About the Author
Patrick Hogan is the CEO of Handle, where the team builds software that helps contractors, subcontractors, and materials suppliers secure their lien rights and get paid faster by automating the collection process of unpaid construction invoices.