How to Decide Between Leasing and Buying for Your Business

When it comes to acquiring assets for your business, such as office space, equipment, or vehicles, one of the fundamental decisions you’ll face is whether to lease or buy. The correct choice depends on various factors, including your business’s financial situation, long-term plans, and specific needs.

Here are some key factors to consider in the lease vs. buy decision:

The Factors That Have Always Mattered

1. Cash Flow: Leasing often requires less upfront capital than buying, as it usually involves lower down payments. This can be beneficial for businesses with limited cash flow or those wanting to use the capital for other growth-related investments.
   
   
2. Cost over the Long Term: While leasing might have lower upfront costs, it could be more expensive in the long term. When you buy an asset, you’ll eventually pay it off, and it can still have resale value. With a lease, you’re essentially renting the asset and making continuous payments.
   
   
3. Tax Implications: Both leasing and buying offer tax benefits. Lease payments can often be deducted as a business expense. Meanwhile, when you buy an asset, you can usually take advantage of depreciation deductions. Speak with a tax professional to understand how each option could impact your business’s tax situation.
   
   
4. Flexibility: Leasing offers more flexibility, as it’s easier to upgrade to a new model when your lease ends. If your business relies on having the latest equipment, leasing may be a good option. Purchasing assets tends to be better for long-term use.
   
   
5. Maintenance: If you lease an asset, the leasing company often covers maintenance and repairs, which can result in savings and reduced hassle. However, if you own the asset, maintenance and repairs are typically your responsibility.
   
   
6. Control over the Asset: When you buy an asset, you have more control over it. You can modify it as needed to suit your business operations. However, when you lease an asset, you’re bound by the terms of the lease agreement, which may limit what you can do with it.

What ASC 842 Changed About This Decision

The list above is the traditional one, and it is missing the thing that moved most in the last few years. Before ASC 842, an operating lease stayed off the balance sheet — so leasing was a way to obtain an asset without showing the obligation. That argument is gone. Under ASC 842 a lessee recognizes a right-of-use asset and a lease liability for essentially every lease over twelve months, so the obligation appears either way.

Practically, the balance-sheet reason to lease has been removed and the operational reasons have not. Leasing still wins where you want flexibility, where the asset dates quickly, where maintenance sits with the lessor, or where capital is better used elsewhere. It no longer wins simply by being invisible.

Compare Like With Like

Because the liability is now recognized, a fair comparison has to include it. Set the purchase case — price, financing cost, depreciation, maintenance, expected residual value — against the lease case measured the way ASC 842 will actually measure it: the present value of the payments over the lease term, discounted at your incremental borrowing rate. Our guide to calculating the incremental borrowing rate covers that rate, and private companies have a risk-free rate election that simplifies it.

Comparing an undiscounted rent total against a purchase price is the common error, and it flatters buying. Comparing a monthly payment against a monthly payment flatters leasing. The present value is the number that makes the two comparable.

Check What It Does to Your Covenants

A lease signed today adds a liability, and that liability lands in the ratios your lender reads. If you have leverage, current-ratio or interest-coverage covenants with limited headroom, the choice can move you against a threshold before any operational consideration is weighed. How ASC 842 affects loan covenants sets out which covenant types are sensitive, and the EBITDA question covers the one most often asked — leasing and buying do not treat EBITDA alike, because a finance lease splits expense into amortization and interest while an operating lease keeps a single straight-line cost above the line.

Classification Decides the Expense Shape

If you lease, classification determines what your income statement looks like for the whole term. A finance lease front-loads expense; an operating lease keeps it flat. Which one you get is not a choice — it follows from the five criteria in ASC 842 lease classification, and a purchase option you are reasonably certain to exercise is enough on its own to make a lease a finance lease. Worth knowing before you negotiate one in.

Remember, the lease vs. buy decision should be based on your individual business’s circumstances. It’s crucial to conduct a thorough cost-benefit analysis before making a decision. Seek advice from financial advisors and accountants who can provide a comprehensive view of the implications of each choice.

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If this guide proved beneficial, please share it with fellow colleagues or bookmark it for future reference. Keep an eye out for more deep dives into the intricate world of lease accounting and corporate taxes and how the ASC 842 Lease Accounting Standard impacts them.