We can safely say that all growing companies need financing to fund ongoing capital expenditures, commonly called ‘CAPEX’ by CFO’s and Wall Street. It goes without saying, also, that even established companies need to replace assets at some point in time.
When companies utilize lease financing they are in effect leverage their capital investments. They could clearly only buy so much with their own capital resources, but borrowing or leasing they can do more than might otherwise have been possible.
There is a technical term called ‘WACC’, which accountants and financial analyst recognize as WEIGHTED AVERAGE COST OF CAPITAL. As fancy as that term sounds, it simply says that if a company understands how much it costs them to borrow, and then can earn more on a new investment than their borrowing rate, well, then It makes sense to lease. Using a simple example, if a company wishes to purchase a new asset that will deliver a 15% return on assets, and their borrowing cost is 10%, the 5% difference is a major economic positive and benefit to the company. It would not make sense to pursue the asset if borrowing costs were 15% and the return was 12%!!
Naturally at all times business owners and CFO’s know that their company can assume only so much debt, as in additional leases, etc. At a certain point there is a threshold that is reached where a company is maxed out on debt.
Leasing also has the ability to defer taxes - in essence its interest free debt. So in these case a major lease financing scenario can also be viewed as a form of deferred taxes, which many financial analysts and bankers view as quasi - equity. And that’s a good thing!
Naturally an aggressive lease financing strategy in effect accelerates capital investment, business expansion, etc. The company does not have to pay out 100% of the value of the asset at inception. In companies where capital expenditure and free cash flow are critical those are important measurements of success. The lower investment in a equipment leasing strategy allows a company to invest in other assets and projects. Leasing therefore increases the speed of investment - the company is trading future cash flows for a lower cash outlay now.
In summary, companies debating a lease or buy strategy must ensure they have their primary data correct, re borrowing costs, expected returns of assets/project, etc. The company needs to clearly assess how long the asset will be used for, and ensure It matches the cash flow analysis they are using on that particular asset or project. Customer need to know their borrowing rates, and be realistic, as we have seen that they will be benchmarked against their return rates.
