To Own or Not to Own - That is the Question
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To Own or Not to Own - That is the Question
So how do you decide what route to take? Lets look at a few quantitative and qualitative factors to take into account.
The Theory of Relativity
Dont worry; were not getting into a physics discussion. Rather, when we speak of relativity, we speak of what effect a purchase will have on your present cash flow. Its a lot easier to simply purchase a $10,000 copy machine if you generally have $1 million in cash at any given time than if your bank account runs more often in the double digits at times. Your first and most important consideration, then, should be what your bank account will look like after you negotiate a deal rather than immediately before you cut a big check.
Planned Obsolescence/The Pack Rat Syndrome
Years ago, the rule of thumb was that you should expect to replace your computers once every three years. Then, the time frame shrunk to 18 months as the rate of technological innovation increased. This presented a real challenge to corporate buyers. If a firm was committed to replacing its equipment on a three-year basis, did it make sense to sink a ton of money into equipment that would be obsolete in a year or two or would the best bang for the buck come from leasing the equipment and trading up every few years to get the latest and greatest hardware?
On the other side of the spectrum are those buyers/companies that tend to draw every drop of usefulness out of a piece of equipment before relegating it to the junk heap. Again, using the computer as an example, there are instances where the latest and greatest would be nice to own, but if all you are doing is typing letters on your desktop, do you really need the latest graphics and speed enhancements? Assuming you plan on keeping your equipment for an extended period of time, buying could really make a lot of sense.
The Numbers - What to Consider
In making an informed decision about the financial aspect of the lease or buy question, you will need some information. Here is what you will generally need to know for your comparison:
- Monthly lease payment
- Any required deposits - do you pay the last months rent at the beginning of the lease?
- Lease term or, if buying and financing, term of note.
- Sales tax rate on lease payments - in many places, not only do you make a monthly lease payment, but you also pay sales tax on it.
- The guaranteed residual value of the equipment at the end of the lease.
- Cost of equipment, if you buy - when calculating this cost, be sure to include any taxes that might be due.
- Allowable depreciation if you buy the asset.
- Borrowing costs (i.e. fees and interest rates).
- Down payment if purchasing the asset.
- Your average, or perhaps assumed average, investment return on idle funds.
- The estimated salvage value of the equipment at the end of the lease term.
- Your tax rate.
Another big factor in calculating cash flow is the tax effect of your decision. If you buy a piece of equipment, the IRS will require you to deduct the cost of the equipment over time through an annual depreciation allowance. If you lease the asset, the rent payments are generally deductible as they are paid. Over time, the tax effects may equal out, but using the theory that a dollar today is worth more than a dollar tomorrow, tax deductibility is a significant consideration.
Does all of this sound a bit complicated? Dont worry, there are numerous free calculators on the market to help you figure the cash flows. This web site has such a calculator, but it doesnt take the tax effects into account. If you think the tax effects could be significant, a web search will yield a calculator that takes these into effect, or simply give us a call. We have the experience and tools to assist you in making your decision.
Happy 4th of July. Remember to celebrate safely.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.