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Is Leasing Really Worth It?
llamaluvr asks: "As I understand it, there are some financial benefits for businesses leasing hardware equipment. Does anybody know what exactly those are, and how much they really help? Do they really outweigh the additional costs of replacing, repackaging, and returning old hardware? How do the size of the business and the computing environment affect these benefits? Additionally, what is the best balance between leasing and purchasing equipment -- would leasing desktops and laptops, but purchasing monitors be best, or should one just lease everything?"
"A little bit of background: I work in the IT Operations department for a BU of a Fortune 100 company, and we lease practically everything right now. We have 4 full-time employees for about 800 workstations, and, while we seem to have enough manpower for managing projects and tickets, we have a tough time getting to returning the equipment, so a lot of it is already late. Complicating this is that many of these PCs are in a harsh industrial environment, and often have at least one failing part, which then costs us a fraction of the entire workstation (for example: a busted floppy might cost us $150 or more, unless we test the PC and replace the part, of course). Corporate has been more attentive to this drain on our time and money lately, and they have talked of outsourcing this process, but in the meantime, we're stuck with it. BTW, we lease IBM equipment through ePlus."
When businesses lease equipment, they write-off the whole amount in that tax year. If they purchase equipment, they have to depreciate it over a number of years. With the large amount of IT equipment, keeping track of what was purchased when, and how much has been depreciated is a CPA's nightmare. Thus, the equipment is leased, even if it ends up costing more money to get lesser capable equipment.
Basically, it's because the tax law depreciates most of that hardware over something like 7 years. So in the first year you'll get to write off something like 20% of the value.
With a lease you expense 100% of the amount you pay as soon as you pay it.
This is why a very common option is lease-to-buy with a very cheap buy option at the end of some number of years. This is essentially an apparently legal scam to allow you to write it all off. (It's legal because the leasor really does still own it until the end)
The next-best option is to sell the hardware the day you stop using it, because then you immediately get to write off the difference between the amount you've already devalued it and the amount you actually got for it. Because computers aren't worth anything much sooner than 7 years, you always get a tax benefit when you sell a computer that just became obsolete.
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Leasing effectively moves the value of the leased item out of the Fixed Assets of the balance sheet, reducing the overall fixed assets. This has the result of improving the ratio of asset turnover, a prime measure of business performance. It also has an effect on the operating statement, as it becomes a straight cost. It is a much more transparent way to deal with something that will probably get cycled out within 3 years. As others have mentioned, your tax benefit mileage may vary.
I am not an accountant, but I am a small business owner so I have some idea about this stuff.
The advantages of leasing are primarily:
1. cash flow benefits
2. tax benefits
One of the primary things that small businesses (well, all businesses, but especially small businesses) have to manage is their cash on hand and their cash flow (when cash shows up, when it leaves) If I have to buy a $3000 server and I pay cash then I need to have $3000 cash right now and that cash goes away. If I lease that server, then I might have monthly payments of $50/month. Over the life of using the equipment I pay more, but at the outset I don't have to have all of that cash around.
Also, when you pay money to buy something of value, for tax purposes you don't take all of that cost off your profit immediately (you pay taxes on profits, not gross income) You have to depreciate it out over a period of time which is supposed to represent the useful life of the equipment. This means that while you might have paid the money out (in cash) you can't claim that they money has all gone away yet for tax purposes. Not fun!
When you lease an item the leasing company owns that capital expenditure and so they depreciate the item. Your monthly payments can be treated as expenses so they come off your taxable profits immediately. Plus you don't have to account for the depreciation, etc.
In my business most of my costs are salaries for my people, not workstations for them to use so workstation costs are a small fraction of my expenses. It makes sense just to buy a decent workstation outright rather than haggle with the lease people and try to return or buy out the eqipment later on. Other businesses will operate differently.
My $.02
Also: If the poster is in an environment where things tend to break often, leasing is probably not for them. The whole point of leasing is that the item being leased gets use beyond what you would put it through, thus extracting enough extra value from it such that it proves cheaper for your company and still provides enough extra profit to the leasing company to justify their expenses. If the item tends to break on your watch, you might as well just purchase.
In general, leasing of anything is optimal if:
A) The item has a long usable lifespan (i.e., damage from use is minimal) and low maintenance costs compared to purchase costs
B) The lessee only needs it for a short time
C) Item devaluation is minimal
Does this really describe your business model here?
What a crazy random happenstance!
My company traditionally purchased their own equipment, but at one point was offered a "killer" deal. We were a major software company which was recently taken over (ahem). The leasing deal looked great on paper (i.e. the Bean Counters LOVED it). In practice, it sucked wind. Not the pleasant kind I find blowing by my window as I type this, but rather more of the offensive sewage variety. It created a maintenance nightmare, added overhead that required more staffing to deal with returns, getting off-lease equipment returned from people in the field, which required new leased equipment, a rebuild, transfer of files, etc. despite the fact that the machines were plenty good enough to handle the current software load for another year. By the time the dust settled, my department vowed never to lease anything so transient as user desktops/laptops. Some large cost items which made sense and didn't require extra staff, tracking, and hidden work requirements were left on-lease. All-in-all, the CPAs can figure out how to get you some bang for the buck either way via depreciation, tax breaks, and what not. Don't be sold on leasing because someone tells you it's a better deal financially. When we ran the numbers after all was said and done, it ended up costing us much more in PeoplePower and requirements to make it all work - and even then it still sucked. Own your own. Accept no substitute.
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One other thing to consider:
leasing is a straight-forward writeoff for tax purposes while buying will involve amortizing the cost over multiple tax years.
"All that glitters is not gold"
We changed from buying to leasing hardware (desktops and servers) about three years ago. The primary reason we changed was to move the costs out of our capital equipment budget into the expense budget. We're not a huge business and prefer to reserve our limited capital for plant equipment.
..." yeah, we "sold" it to you for $20, including keyboard, monitor, mouse, and a Windows license.
On the other hand, I wanted to change to leasing anyway. I time-phased the replacement schedule, so we replace 1/3 of our desktops/notebooks every year. For desktops, everyone getting new hardware every three years not only gives us a fair chance at keeping hardware fairly capable of running new software, it also cuts down on user complaints -- "They get new computers; we have to use old stuff!" Everyone knows that there's a three year cycle and when your turn comes up, you get new kit. It does also help with the disposal problem: our society is so saturated with cheap PCs that most charities, schools, and non-profits don't want old stuff. I'm willing to sell (or give, depending,) obsolete stuff to new employees but that hasn't worked terribly well in the past. Too many folks want too much support -- "Can I put a wireless network card in this old computer? What can I do to make it run this game my son bought?" -- that sort of thing. A few employees try to take advantage -- "You sold me this computer and it won't
A downside is that for most leasing companies, you have to keep the original packaging material to ship the stuff back to them three years down the road. Never underestimate how much space all those boxes are going to use up, not to mention the time you'll spend trying to match PCs, monitors, laptops, etc. to their proper box.
For servers, it means we get new servers every three years, which means that I don't have to hugely overspec the thing when I buy it in the hopes it will prove useful more than three years down the road. It also means that it gets complicated if you decide a year later that you need more memory or additional processors. The leases won't end at the same time or you buy it and end up with a box of useless kit when you return the server. It also means that for better or for worse you're going to end up doing server replacements (and all that entails, time-wise,) every three years. We time-phased this, too, so not everything gets replaced at the same time.
We recently decided to go with five year leases on the servers. The rate of cycle-eating inflation with applications hasn't been too severe lately, so we think that even if it won't be top-of-the-line three or four years down the road, we can still find something it can do. For example, if the new one gets too slow running the database, maybe it could host a different application, or a set of aplications known to play well together when hosted on the same box.
On the whole, after three years (one full cycle,) of leasing, I prefer it over buying. I spend a lot less time worrying that I'm buying too little hardware for my needs down the road and we're saving capital for other uses. I don't worry about what to do with older equipment any more and I know that when the manufacturer's warranty runs out, the hardware goes away and is replaced by new stuff with new warranties. As a smaller organization with limited resources, our little group hasn't spent noticable time on hardware issues for the past three years and that's a good thing.
Rb
People are missing the obvious. Companies lease because they don't want to pay a lot of cash up front. Why drop $1.2m on 1000 computers when they can lease them all for at $40k a month for three years? It's the same reason people finance their cars. And yes, leasing is financing. Don't be fooled by the accounting treatment. When you lease, you make a promise to pay X for Y months, and then give back an asset worth Z. X*Y+Z is the cost of the asset plus some interest. Companies have two main financing alternatives if they want to buy an asset. They can sell stock or issue debt. The problem is, those two actions show up on the balance sheet and weaken the company's financial picture. Leasing doesn't show up on the balance sheet (also called off-balance sheet debt) and they get a tax savings for whatever they buy, and interest rates are usually good (because it's a real asset), so leasing's become the third, and typically the best, alternative for acquiring a capital asset. -- Tristan Yates, author of IT Leader
Tristan Yates
I agree completely, but feel an example will help everyone understand why the poster is correct.
At the end of the lease an asset has residual value. That residual value is determined when you execute the lease. The benefit of leasing comes when the asset has a high residual value; thus the lease payments can be viewed as a loan of sorts, a loan for the difference between the purchase price and the residual value.
For example, if the purcahse price of a server is $10,000, and its residual value after 3 years is $2,500, then the lease is effectively a loan for $7,500, repaid over 3 years. Thus, if you intend to refresh the server after 3 years, you get use of the server for 3 years for $7,500 (plus interest); whereas a purchase of the device would ential use of the server for 3 years for the cost of $10,000 (plus either interest or "the cost of money") and less what you manage to sell it for.
The potential gain from leasing must then be compared with the overhead associated with maintianing an organisation that tracks down and returns assets ON TIME; since late fees detract from the benefit.
There are also non-traditional reasons for leasing. In a former job my boss introduced the leasing of all servers and desktops, where the lease costs were paid by Corporate IT (instead of each department's budget). This allowed Corporate IT to standardise the hardware configurations, and enforce regular refresh of assets, where old assets did not hang around for extended periods of time consuming software licenses and support.
You example of buying components and assembling boxes yourself is exactly what you do _NOT_ want to do in a critical production environment.
Establish long lasting relationships with large systems integrators and builders such as HP, IBM or SUN. Work with your vendors to get a solution that matches your requirements.
Then, hold your vendor to the agreement. If your not getting what you need, call your sales rep. Call the VP of customer relations/support for the company. Talk to the money people rather than the technical people if you are not getting support. It will get fixed, and quick too.
As all things, the answer is "It depends".
I'm a fan of the $1 buyout lease, for tax purposes this is the same as buying. If the lease is structured more in line with a FMV (Fair Market Value) buyout, it would usually not be treated as such, and the leasing company would take the write off (helpful for a start up that won't be making a profit and thus makes no use of the tax write off, since the leasing company IS profitable and thus can bundle the tax savings into the payment
Another potential benefit is in the company books. Since the company doesn't OWN the equipment, it doesn't show up as an asset, and since it can be treated as a monthly "service", the debt doesn't have to be disclosed on the books like a loan would.
You are in a maze of twisted little posts, all alike.
IANAA (I am not an accountant) but I used to do the books for my old computer shop, so I know a bit about it. I may be wrong on this one, though. YMMV.
Generally, when you purchase something, it goes down in your books at cost, and stays at the value you purchased it at. Another account keeps track of the depreciation - it's calculated differently depending on what it is, but generally it's a curve. The lowest spot on the curve is at the end of useful life, when the value recorded for the machine minus the depreciation is the amount you've estimated you can salvage it for.
If you're buying a piece of equipment at the end of a lease, it's the same thing. You move it into an asset account at the value of what you purchased it for, and start depreciating it. The main difference here is that you're probably only going to have the machine for a short time, so your depreciation is very fast.
Bear in mind that to people who don't work with accounting methods, they don't make any sense. It's all based on 14th century financial theories and it takes some training to figure out exactly what's what. The methods are standardized though, so it's always roughly the same for every company (barring international differences).
Those who can't do, teach. Those who can't teach either, do tech support.
My company currently leases their computer equipment and it's a nightmare. The CFO sayes "it's good because you always have fresh equipment in the environment" which masks what's really going on. The technology is being driven by the lease, rather than corporate need. You can replace purchased equipment every three years also, nothing is preventing you from doing this if you realy want "freshness". By leasing you are forced to upgrade and migrate systems that do not necessarily need upgrading and you need to take time away from other projects to do it.
- the lease term 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
- ownership of the property is transferred to the lessee at the end of the lease term
- the present value of the lease payments exceeds 90% of the fair market value of the property
If none of these conditions are met, the lease is an operating lease, which means that the payments are expensed when they are made.If the company exercises a purchase option at the end of an operating (expensed) lease, the lease-end purchase price is capitalized and amortized over the remaining useful life of the asset; it has no effect on the original classification of the lease. I don't remember the rule regarding an exercised purchase option at the end of a capital lease (it's been a long time since I had to know this). FASB Statement 13 covers this in excruciating detail if you really want to know more, but beware of all the interpretations and amendments...
Funny this question should come up now.. Just 10 minutes ago I finished reading an article in Health Data Managment about hardware maintenance. In the paper version they had a special sidebar about leasing vs buying. In the electronic version, it's at the bottom.
In short, they found that if you want to turn over your computers frequently and on schedule, and were good at asset managment, leasing was generally favorable. But if you decide you want to turn them over ahead of schedule, make changes to the systems during their use (like add memory), or aren't amazing at tracking assets, then the administrative burden could be really heavy.
They also had a neat description of a procurement system that facilitated the vendor bidding process.
Overall, the article is a nice balanced look at the topic.