Generally, this means that business is good despite the recent economy. As many of you grow your operations or replace the equipment necessary to keep up with your customers’ demands and general competition, leasing your equipment has been a staple within this industry since the beginning.
Leasing is the main alternative to conventional methods of paying for equipment purchases. Pizza owners and other hospitality operations have increasingly turned to leasing as an avenue for financing their capital expenditures. Leasing equipment can help cash-strapped owners take their businesses to the next level. With lower upfront costs, leasing offers pizza owners an option for positioning themselves to take advantage of potential business opportunities on which they might otherwise miss out. Key ingredients in a lease can be financed and spread out over the life of the lease, such as: installation, build-outs and maintenance agreements on specific equipment. This is very important to the operator from a cash flow view, as they don’t have to deal with these up-front costs. Let’s review three other benefits of leasing.
Speed and Simplicity
For amounts typically as high as $100,000.00, leases usually can be obtained, often the same day, on the basis of a one-page application. Leases involving larger amounts may require more extensive application procedures, but less financial information is required than that for purchasing equipment.
Smaller Down Payment
Conventional lending can require down payment of as much as 20 percent of the purchase price. In contrast, leases can be structured so that one or two are due at the start, which amounts to a down payment of about 5 percent of the equipment price. There are some leasing companies that don’t require any payments or they can defer the payment up to three months, which is a great cashflow structure.
As pizza owners, try and think of leasing in this light: “If the equipment appreciates, buy it (cash or loan). If the equipment depreciates, lease it.” Most business owners realize that all equipment depreciates. Leasing allows them to redirect money that would otherwise be earmarked for equipment depreciation to completing new projects or for items like advertising.
A variety of payment plans can be worked out to better coincide with a company’s cash flow. Lease contracts can be structured to include special variable payments to help see your pizza shop through some lean months. For instance; a small independent needed a lease. The bulk of his operation was tied to a small university. During the summer months, when the 4,000 students went home, his operation would drop 35 percent for those three months or so. This operator set up a nine-month payment plan with no payments from June through August for the four-year term of his lease!
On the flipside, conventional lenders, however, typically offer lower interest rates than do leasing companies. Some pizza owners have developed personal relationships with their in-town bankers, which can ensure smoother transactions with minimal formalities. Still, others may purchase only one new piece of equipment each year and may not benefit from the potential tax savings offered by leasing companies.
Tax and Booking Considerations
Pizzeria operators that set up leases to meet the U.S. Internal Revenue Service (IRS) guidelines can treat their lease payments as equipment rental expenses for tax purposes. Lease payment deductions can compare favorably to first-year depreciation when copying with mid-year conventions.
Kitchen equipment and POS systems also can be leased for shorter terms than the IRS depreciation basis, which basically allows a company to depreciate an asset more quickly through lease payments. For example; a company may acquire a pizza oven with a five-year lease that would qualify as a seven-year asset if it were purchased.
Pizzeria owners should bear in mind that lease payments do not figure into the alternative minimum tax (AMT). A penalty tax of sorts, the AMT begins with regular taxable income and adds certain adjustments known as preference items. The greater the amount of reference items, the higher the AMT base and therefore the tax. A major preference is accelerated depreciation. A lease does not create a preference item, however, so payments are not figured into the AMT.
The listing of an asset and no corresponding liability is booked for leases that are set up to meet IRS guidelines. Because a company does not own leased equipment, a lease typically is accounted by showing in accounts payable the current liability for the next 12 monthly payments on the balance sheet.
Leasing is an option for companies that want to remain flexible enough to take advantage of state-of-the-art (POS systems, ovens, etc.) advances in equipment sooner than financing arrangements for the outright purchases may allow. It is also an option for companies that fear maintenance costs may escalate to unacceptably high levels as equipment ages. These are costs that they would be forced to assume if they owned the equipment. Leasing may also be attractive to the pizza operator that takes on special projects (i.e. local school lunch contracts) that may require special use of equipment. (i.e. catering equipment or delivery van, etc.)
Leasing may be the only financing option for used equipment purchases. Conventional loans for purchasing used equipment are typically difficult to obtain. Because used equipment has been depreciated already, traditional lenders often fear that a borrower may feel less incentive to repay a loan on equipment that may be worth less than the amount owed. This preserved risk makes many conventional lenders wary of loaning money for used ovens, furniture, coolers, etc…this is especially true when a new pizza operator acquires a new franchise or strikes out on their own.
Leasing maintains cash reserves because operational capital in-hand is not spent and bank lines and any lines of credit can be used for other growth areas of a company. The fast approval process of leasing can also give you, the operator, better negotiating power when haggling over the price of equipment with your vendor.
The decision on whether to lease or buy your equipment often hinges on a company’s particular situation and its cash flow. As the owner of your pizza establishment, ask yourself these questions:
- Is the term of the conventional loan sufficient for my situation? If a conventional lender offers a 36-month term when your company could benefit form a 60-month lease to assist its cash flow, a lease may be a better option. If the shorter term is more attractive, a conventional loan may be the choice for you.
- Will the terms and payments of a lease or loan be flexible enough to coincide with fluctuations in the company’s cash flow? Will payments be fixed for the term of the loan as they are in a lease? Or should a company be concerned with a possible rate increase a few years after the conventional loan’s period begins?
A business owner who thinks he/she may win a lottery and pay off the lease early may find that a conventional loan may be a better financing option. Accounting practices for leases can make payoffs expensive. A company would be better off financially by investing the proceeds it might use for an early buyout of its lease rather than using the money to pay off the lease.
A pizzeria owner considering equipment acquisition should keep in mind that the purchase option is the main determinant of a lease’s tax deductibility. Many capital leases ($1.00 purchase options) may not provide the tax break a company seeks. Owners considering leasing or a conventional loan for an equipment purchase should discuss these issues with its accountant.
Always remember that a leasing company should have a working knowledge of a company’s industry and the equipment used in it. Such background often contributes to faster approvals and better comfort level for the customer.
As our economy continues, many pizza owners may want to consider leasing as an option for the financing of new kitchen equipment, POS, signage and other pizza equipment. Leased equipment can help your company grow, maintain cash flow and position itself on the right track for a more prosperous future.