One of the ways construction firms can gain a significant advantage over their competitors is by using the latest state-of-the-art heavy equipment and machinery. However, acquiring the necessary equipment requires a significant cash outflow, which the company may not always have. And making a huge dent in a company’s current cash, especially in the construction industry, poses a major risk to the company.
Instead of using cash to buy the equipment outright, your business has 2 options—equipment leasing and equipment financing. The decision to use leasing or financing to acquire equipment involves several considerations unique to the company. These include the type of equipment to be acquired, how often the equipment will be used, the maintenance and repair costs, and the resale value.
Which one should you use to acquire the necessary equipment? Here’s our useful guide to equipment leasing and equipment financing.
Equipment leasing and equipment financing are 2 major ways to acquire equipment, but they are structured differently.
With equipment leasing, a piece of equipment is rented from a lender for a specific period. In return, the borrower pays the lender monthly payments for the duration of the lease. When the term of the lease ends, the borrower can either renew the lease, purchase the equipment, or return it.
Equipment financing, on the other hand, refers to borrowing money from a lender with the specific purpose of buying a piece of equipment. The financing firm can loan most if not the entire cost of the equipment. In exchange, you need to pay the loan along with regular interest payments, depending on the terms of the loan.
The difference between equipment leasing and equipment financing lies in the ownership of the piece of equipment. An equipment lease lets you rent a piece of equipment from a vendor, but you don’t own the equipment during the lease term. You may purchase it if you have that option at the end of the lease agreement. With equipment financing, you will fully own the equipment when you pay the loan according to the agreed terms.
Some pieces of equipment risk becoming outdated. If you are considering using a piece of equipment that is in danger of being obsolete in the future, the best option is an equipment lease. Since you do not own the equipment, you will not shoulder that risk. In addition, the lease terms are usually between 2 and 7 years, which will usually not outlast the equipment’s useful life.
One of the major advantages of equipment leasing is its low impact on cash flow. Instead of a down payment or collateral, leasing spreads the payments over the duration of the lease, leaving your cash free to be used for other opportunities like paying expenses or funding your growth.
The disadvantage of choosing to lease a piece of equipment is the higher total cost compared to an equipment loan since the lender includes an effective interest rate in your monthly payments. Additionally, the equipment that you want may not be available and you may need to settle for different equipment.
If you are considering using a piece of equipment that you know is durable and will last a long time, your best option is equipment financing. The terms of the loan depend on the type of equipment you need, and usually, the lender will front around 80% to 100% of its entire cost. The qualification process is easier since the equipment itself will serve as collateral.
One of the downsides of an equipment loan is the required initial down payment, which can be a challenge if you are having cash flow issues. In addition, you have the full ownership of the equipment so you will assume the risk of owning obsolete equipment in the future. This risk is why it is advised only to get an equipment loan when you know the piece of equipment will last a long time.
The decision of whether to lease or finance your equipment acquisition depends entirely on your business situation. Before deciding which course of action to take, evaluate your business goals and choose which method aligns with your objectives.