Leasing in today's changing market

Sept. 1, 1998
Finance companies comment on the advantages and give advice about leasing capital equipment.

Finance companies comment on the advantages and give advice about leasing capital equipment.

There are advantages to both buying and leasing capital equipment. Cash purchase of machine tools offers ownership and more control over finances. In turn, ownership provides the benefits of depreciation and the value of the equipment as an asset. "If you plan on using the equipment in your operation forever, that's the way to go," says Bill Roden of LCA, a division of Associates Commercial Corp.

But in today's fast-paced market "forever" can be a dangerous notion, which is why more and more companies are looking to capital equipment lenders for leasing alternatives. When exploring their options, end users should consider the full advantages of leasing, understand the different types of leases, and know what to look for when establishing a relationship with a lessor. According to Bill Purcell, president of the Machine Tool Finance Group, Portland, Oreg., over 80% of American businesses today have used leasing at one time or another. "It just doesn't make sense to pay cash for depreciating assets, and more companies understand this," Purcell says. "They want to pay to use the equipment as opposed to pay to own it."

Roden agrees, noting that more small companies are taking on tax leases. "Medium and small-size jobshops are becoming more sophisticated," he says. "They are worrying less about owning the equipment and more about making the best possible financing decision."

Leasing offers advantages such as a low monthly payment to conserve working capital and improve monthly cash flow. "You only have to pay for how much the fair market value of the machine drops during the period of time you have it," Roden says. "You're paying for the use of the machine rather than the value of the machine, which can positively impact your cash flow."

Another major benefit of leasing, Purcell adds, is protection from obsolescence, because a company can return the equipment after a few years. "This is important in an ever-changing business like the machine-tool industry," he says. "Also, depending on how the lease is structured, there may also be certain tax advantages."

In a tax lease, monthly payments can be written off as an expense, and so the financing absorbs the depreciation. According to Roden, this differs from a cash purchase, where the asset must be on the accounting books. In that case, all that can be written off is the depreciation of the equipment.

In an operating lease, the machine tool is considered a rental instead of a purchase, and so the asset does not have to be capitalized. Indeed, the entire transaction is off the company's balance sheet. "This means you have the income the asset is producing, but not the asset it-self, on your books," Roden says. "This improves your return on assets, and makes your operating ratios look better. A large company can then be more appealing to investors, and a small company can improve its credit strength for bank lenders."

Yet one of the more popular leases has been the nominal option lease. This alternative lets companies buy the equipment at the end of the lease for a nominal amount (anywhere between $1 and $100). "This lease is really nothing more than a loan," says Roden. "These leases don't qualify as a tax or operating lease, although some who are getting them may be treating them as that. The fact is, if they had an accountant look at their finances, or if the IRS audited them, they would not qualify as leases. So understand what kind of lease you are getting, and talk to your accountant or tax adviser about how it should be treated on your financial statements."

Choosing the financing company is as important a decision as choosing the right type of lease.

"Leasing companies must commit to the transaction and have enough resources to make the loan," says Fred Hochman, senior vice president at Orrick Credit Alliance. "End users should make sure the financier has a long-term commitment to the industry and consider the company's reputation for working with customers during the more difficult economic times."

A spokesman at Newcourt Financial appears to agree with Hochman. According to Newcourt, the machine-tool industry is an attractive market to lenders during good times. However, many players exit as soon as the market shows signs of softening.

Purcell recommends endusers do business with a reputable source who understands their business and the equipment they're buying. He says the company should be able to choose how they want to finance their equipment from a financier's available options.

There are several lessors that specialize in machine tools, and Roden suggests looking for a company that has the financial ability to handle all their needs. This means lessors should finance, hold, and service the leases themselves for the entire contract.

"Some small companies put transactions together and then sell them to someone else," he says. "When you get an equipment lease, it's important to know that the person you're dealing with will be there when you're three or five years down the road and have questions or business changes. When you deal with someone who doesn't keep and service the accounts himself, you never know who you're going to be dealing with. For this reason, larger financing companies are often a better bet."

He adds that large, self-funded lessors will also be better able to fulfill a growing company's financial needs.

When it comes to end-user growth, Ed Hetherington, vice president of the CIT Group, says companies can generally stay with one lessor, because a relationship has been built with the lessor over the years. "We have many companies that have been with us for years and we continue to service all their leasing needs," he says. "Staying with one lessor is definitely possible, even with growth."

Hochman agrees and claims that any decision to change lessors after company growth is based upon the size of the lessor itself, and the comfort level it has at a certain dollar. "Al-though as large as banks, commercial finance companies do not have to report to government regulators," he says. "This enables us to work with our clients more easily."

Even with all the benefits financial firms offer, banks still play a vital role in end-user growth. Purcell recommends end users use banks for their working capital lines, because "a healthy banking relationship is vital to any company," but says they should finance their equipment with another party. He says using a bank for machine-tool financing could limit future borrowing capacity. "Customers have to be careful," he says. "If they give a bank all their business, there may come a time when the bank will not continue to lend them money."

Roden has similar advice, and suggests end users have more than one source of financing. "Banks are balance sheet lenders, while financing and leasing companies are collateral lenders," says Roden. In other words, a lessor considers the value of a company's collateral more than a bank would. He says this is what makes financing companies better suited for the machine-tool industry.

"Machine tools are very good collateral, and that can help strengthen a transaction," says Purcell. "Asset-based lenders recognize this, as opposed to a bank or some other source who might not be as familiar with the industry." He adds that many financing companies understand the profile of a borrower in the machine-tool industry better than outside banks can.

Roden feels end users are becoming better educated and wiser purchasers, but he still advises they understand what it is they are getting, whether it is a lease, a loan, or a cash purchase. "Know the difference between each option, as well as the difference it will make on your company," he says, "Financial calculators are cheap and easy to use, and can even determine what the interest rate will be on a particular financial arrangement."

He also recommends talking to an accountant or a financial adviser before making a decision to finance any equipment. "After all," he says, "five years is a long time to pay for a mistake that you could have easily resolved by taking a few minutes at the very beginning."

Information supermarket

The Commercial Shopping Network (CSN), started by GE Capital, is a marketplace of used equipment on the Internet. By locating and merchandising machine tools, users of the CSN website may be able to cut capital equipment acquisition costs, maximize resale of equipment, and improve internal capital asset management. The network is located at www.gecsn.com.

"Quality pre-owned equipment is often difficult to locate for buyers and too costly to sell for owners," says Tom McDonald, vice president of CSN. "We are building a globally accessible environment for the efficient disposition and acquisition of pre-owned assets."

Machine tools sold on the web-site can be off-lease equipment, machinery from metalworking manufacturers, and equipment from companies using the CSN's Asset Management. This service uses an Intranet to track a company's internal assets, redeploy surplus or idle equipment, and to locate needed assets. Machines no longer needed for production can be transferred to the CSN for sale.

Machine descriptions are provided by the equipment owners, however, so the customer may want to exercise caution when making a purchase decision. Photographs, videos, and contact information can make some buys safer than others. CSN is expected to include equipment condition evaluations, trading assistance, and on-line finance and insurance applications later this year.