Running a business requires much forethought and planning. According to the Small Business Administration, over a third of small businesses fail in their first two years. A driving force behind this high failure rate is the mishandling of finances and general ignorance of a business’s financial viability. Insufficient capital and a lack of thorough planning are also frequently cited reasons as to why small businesses go belly up. Many smaller companies simply fail to anticipate costs like unpredictable liabilities and don’t have adequate insurance.
As any entrepreneur knows, starting a new business venture from the ground up requires significant investments. In addition to real estate and human capital, most businesses also rely on a variety of equipment to produce their proprietary product or facilitate their service. Without a steady flow of revenue at the onset, business owners are forced to look elsewhere for initial capital, and most often turn to equipment loans.
The leasing process can be blinding; entrepreneurs are so focused on obtaining approval and managing the other financial responsibilities of launching a business, that planning for lease repayments often falls to the wayside. But understanding up front how much a specific lease will cost your venture down the line is an integral aspect of financial planning and revenue forecasting. However, for most small business owners, running this type of evaluation is daunting, which is why the Currency team is available to guide you through the process.
Before we dive into the nature of repayment calculations, let’s first explore the dynamics of business equipment leases.
The Anatomy of a Business Equipment Lease
Business equipment leases are comprised of a contract between two parties: the lesser and the lessee. The lesser is the owner of the equipment and agrees to allow the lessee to rent the equipment for a predetermined rate over a specific amount of time. Over the course of the lease term, the lessee is required to make monthly payments. At the culmination of the term, the lessee has three options: the business can either return the equipment to the lesser or buy the equipment outright at fair market value or, simply, continue leasing. Many small businesses choose equipment leases because these structures eliminate upfront investment costs. The additional benefit of opting for an equipment lease is that these payments can often be written off as business expenses come tax season.
Due to the legal nature of this agreement, both parties agree to potential consequences should they fail to meet the demands of the contract. Understanding the boundaries of your unique equipment lease contract is necessary to adequately project how much your business may spend on a month-to-month basis to cover the costs of your equipment.
To understand the value of a repayment, you have to determine the following factors:
1. Equipment Value
2. Type of Lease
3. Lease Term
4. Effective Interest Rate
5. Equipment Life Expectancy
In addition to reviewing the terms of the agreement, it’s also in a business owner’s best interest to do his due diligence on the value and lifespan of the equipment. For example, if a business owner agrees to lease a brand-new piece of equipment, the agreement will result in higher monthly payments. On the other hand, if the equipment has been previously owned or is nearing its projected lifespan, the monthly payments should come down significantly. Understanding and negotiating the structure of a business lease is the first step to arriving at a fair repayment calculation.
Type of Lease
There are two primary types of leases: dollar buyout and fair market value lease. A dollar buyout lease refers to a type of lease wherein the lessee has the option to purchase the equipment at the end of the lease term for $1.00. Often dollar buyout leases are accompanied by higher monthly payments. Fair market leases refer to agreements where lessees can choose to purchase equipment at the end of the term for the supposed market value. These leases are often associated with smaller monthly payments but may result in higher buyout rates at the culmination.
The lease term refers to the agreed upon length of time a lessee has to make monthly payments toward an equipment lease. At the end of the term, the lessee can choose to purchase the equipment.
Effective Interest Rate
Over the course of the term interest is added to the repayment amounts to cover the costs lessees accrue. Interest rates for equipment leases are typically up to 26%.Equipment Life Expectancy – The life expectancy of equipment is dependent upon the type of equipment, as well as the shape it is in upon commencement of the lease.
Together these components comprise the five variables taken into consideration when it comes to calculating leases. While lease calculators are available to help you ascertain rough estimates, you can also reach out to Currency at 877-358-4595 for extra guidance and insight into potential costs.