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Unfortunately, when it comes to the question of whether a sign business should rent, lease or own the equipment used in its operations, few sign professionals are able to accept the fact that there is no one right answer that fits everyone or every situtation.

When a business is starting up, buying equipment is one way to build equity in the sign operation. As the business matures and builds a sound financial platform with strong net worth, then questions such as: is the value of depreciation on my equipment worth more to me than, say, my ability to make payments and keep debt off my balance sheet?

Leasing, instead of purchasing can be a cost-effective option, especially for those sign operations that don’t have cash on hand but need the equipment. In fact, many sign operations that do have cash to invest have found that by leasing, they can regulate their cash flow more effectively.

Leasing
Who leases? Everyone does, at least according to the Equipment Leasing Association (ELA), a leasing industry group based in Arlington, VA. The ELA claims that 80 percent of U.S. businesses lease all or some of their equipment. In fact, more businesses, particularly small businesses, acquire their new equipment through leases than through loans.

Obviously, each equipment acquisition option, buying, renting and leasing, have balance sheet and tax considerations. A sign business or operation that owns a piece of equipment has the right to take depreciation deductions, for example. If the operation leases, it takes an expense deduction. Which is better for your operation?

Rentals
To many sign professionals leasing is for the long-term, one year or more, while renting can be for a day, week or even a month or more. And, with over 12,000 rental centers operating in the U.S. and Canada, equipment rental is a growing business. More and more sign operations are using rentals as their primary source of equipment acquisitions, not only to meet specific equipment needs on projects and jobs.

Many sign professionals claim that when factors such as downtime, servicing, costs, storage, insurance and disposal are considered, rental is frequently the least expensive option. The financial benefits of renting include higher profits, tax benefits and the ability to take on larger, more profitable jobs. After all, sign businesses that rent don’t have to buy, maintain and haul equipment from job site to job site.

Comparing apples and oranges
Leasing usually means lower monthly payments than are possible with a loan. With leasing, the sign operation conserves its working capital and avoids cash-devouring down payments. On the downside, leasing means paying a higher price over the long term.

Leases are usually used where the equipment is needed for longer periods of time, usually over 12 months. Leases are ideal for long-term contracts where low equipment costs are necessary elements in bid equations or where extra equipment might be needed for a single job. The reason given most often by those leasing equipment is the need for equipment flexibility. However, cash flow and financial reasons are also important factors in the decision to lease equipment. Leasing permits a close matching of payments to the revenues produced by using the equipment. Leasing keeps debt lines open for working capital rather than tied up in capital expenditures.

There have long been incentives in our federal and state laws to invest in new equipment. All-too-often a sign business cannot use those incentives. Thanks to leasing, however, many of those tax incentives and benefits can be passed through to a sign operation in the form of low rental payments. After all, the owner of the equipment, the leasing company, utilizes the depreciation or credit incentives, passing the savings along in the form of lower equipment lease costs.

An obvious disadvantage when leasing is that the sign operation doesn’t build equity making financing a little tougher. On a lease, the operation is making payments in advance and the decision to lease is based on the customer’s ability to pay, not the value of the equipment. When it comes to the operation’s cash flow, however, leasing payments are usually lower than financing.

Off-balance sheet, not off-the-books
Two kinds of leases are generally used today: operating leases and finance leases. Deciding which to choose depends on the sign operation’s cash flow, equipment needs and its credit worthiness.

An operating lease can be compared to renting equipment, occassionaly with a long-term option to buy. Users enter into an operating lease for a period of up to 75 percent of the equipment’s life. During that time, the sign business leasing the equipment pays only a portion of what it is worth, based on the term of the lease and the residual value left at the end of that lease.

Because the acquisition is a lease rather than a purchase, users can use payments as an off-balance sheet item. Lease payments are, in effect, written-off as operating expenses. At the same time, the sign operation utilizes the equipment without putting the cost on its books as a debt.

Unfortunately, this also means that the sign business/lessee forfeits the depreciation deduction for the equipment; that deduction belongs to the vendor or finance company. And, at the end of the lease term, the equipment is usually turned back in. Should the sign operation decide it will keep the equipment, the purchase price is based on the residual value of the equipment, usually at or above market value.

This is not always the case with a so-called finance lease, which sets end-of-lease purchase prices before the lease goes into effect. Finance leases are more like true rent-to-own scenarios. Those sign operations that want to own their equipment at the end of the lease, but don’t want it on their balance sheets at all, choose this option.

Because it is not an outright purchase, there’s no down payment, though many companies put something down to lower monthly payments, payments that typically stretch between three and seven years. Still, it’s not uncommon to see businesses using this option to finance the equipment’s entire value.

Because finance leases end in ownership, businesses using this type of lease treat payments as a direct expense item, which often means the difference between a profit or loss. On the plus side, this also means that sign operation can write-off the equipment’s depreciation. And, some sign businesses end up turning in or trading in their equipment anyway, even though it means they’ve probably spent more than they would have if they went with an operating lease to begin with.

A fairly recent phenomenon: vendor leasing or captive financing further complicates the lease/buy decision, In the past, most financing and leasing was arranged through a third party ­ a leasing company, bank, equipment manufacturers and distributors.

Facing smaller and smaller profit margins and increased competition, many manufacturers and distributors recognized an opportunity. After all, if they lease equipment to customers, they make money twice ­ on the sale of the equipment and from the percentage points gained from financing or leasing deals. What’s more, customers are more likely to remain loyal if the entire purchase experience is conducted through a single source.

Defining apples and oranges
Is your lease really a lease? Under our tax laws, it is a narrow line between a lease and a purchase disguised as a lease. As defined by the tax rules, a capital purchase has occurred if the terms of the lease agreement contain one of the following criteria:

• You have a “bargain buyout” in which you can purchase the equipment for a token amount at the end of the lease.
• You are leasing the equipment for 75 percent of its useful life.
• The total payments made during the period of your lease equal more than 90 percent of the fair market value of the equipment. Keep in mind that payments include finance charges and sales taxes and they need to be deducted to find the true price you’re paying for the equiment.

The ever-vigilant Internal Revenue Service frequently challenges leases as disguised purchases - which means you would not be able to deduct your monthly payments. Back taxes, interest and penalties can add considerably to the cost of any equipment acquired in a disguised purchase.

In general, sign operations with a strong cash position and good financing options can often buy needed equipment outright. If obsolescence is a concern, a short-term operating lease or rental will provide the biggest advantage and the most flexibility. However, if cash flow is an issue and the equipment must remain operable for longer periods, a long-term capital lease with a fixed residual payment will usually result in lower monthly payments.

But is leasing the right option for your sign business? Weighing all of the factors unique to your operation may surprise you.