Focus on Leasing: Leasing Vocabulary
Posted on Fri, Feb 19, 2010 @ 09:51 AM
Greetings! My name is Jeff, and for the next ten weeks I am going discuss the topic of technology leasing. So, before we get started, I think it's important to frame up our conversation and find some common ground. Let's take a moment to quickly build some value into our conversation.
From an IT perspective, I know that leasing and financing are not the hottest topics, and I can bet that learning about leasing is not in your top 10 priorities. Having said this, let me take moment to set the stage with the following scales.
The Cool Scale (1 - 10):
- Technologies such as VoIP, Visual Communication, and Virtualization - 10
- Leasing - 0 (Didn't make the list)
- Leasing cool technologies such as VoIP, Visual Communication, and Virtualization - 3
The Importance Scale (1 - 10):
- Having the appropriate technologies that drive down the cost of doing business - 10
- Appropriately financing those technology investments in order to maximize ROI - 10
So, even though leasing may not be very cool, per se, having knowledge about the topic can certainly help you make the case for obtaining the technology your organization needs in the most cost-effective way. My goal over the next ten weeks is to help those who make technology investment decisions better understand leasing, and how it can positively impact your future technology lifecycle refresh projects.
As the IT decision maker, it's important to be able to have relevant conversations with your CFO, the manufacturer or OEM who makes the products you're considering, and the bank or leasing company that has been recommended to you. This will help you find some common ground with finance, and even make better-informed recommendations for new technologies. As we move forward, I encourage you to ask questions and provide feedback. I sincerely look forward to assisting you in meeting your business goals and objectives.
What are the important terms to understand when considering leasing?
To lay the foundation for future posts on technology leasing, following are some general leasing terms and what they mean. Understanding this vocabulary will help you ask better questions, and get better answers when engaged in a leasing conversation.
Time Value of Money
This is the fundamental, underlying principal that guides investment decisions. I'm offering you a risk-free return, no strings attached, however you have to pick from only one of two options:
- Option 1: I will give you $100 today
- Option 2: I will give you $100 a year from now
The time value of money simply suggests that the best option is to take your $100 today. Why? Because $100 today is not worth $100 one year from now; if you wait a year, you are essentially losing money. The simple takeaway is that money now is better than the same amount later.
Lessor
The lessor is the party/company/bank who is leasing the technology products and service to you. Though you may have a technology consultant guide you through options and offer advice, this company is typically not your lessor — the lessor is always a bank or other financial institution. If your technology partner (VAR) highly suggests that you lease directly through them, as opposed to evaluating multiple lease options, run!
Lessee
The lessee is the person/company leasing technology products and services. (This is you.)
Term
This is the length of the lease agreement. Typical technology leases range from 24-60 months, depending on the technologies being leased; however, a lease can be for any term. When comparing lease options, do not fall into the trap of comparing dissimilar lease terms. Make sure you compare "apples to apples."
MSRP
You most likely already know this term, but it stands for Manufacturer's Suggested Retail Price. Many advertised lease offers are based on MSRP or above. However, the MSRP is not necessarily your final price.
Capitalized Cost
This is basically the negotiated price of the technology products and services. Think of this as your complete bill of materials (BOM). Capitalized cost becomes one of several figures used in calculating a monthly lease payment.
Residual Value
This is the lessor's prediction of what the technology products will be worth at the end of the lease. The residual value is also important because it affects your monthly payment: the higher the residual, the lower your monthly payments.
However, software and technical/professional service have no residual value because the leasing company cannot resell them at the end of the lease. For this reason, bundling software and service into one lease can have a dramatic affect on your lease rate.
Sales Tax
If you hate paying taxes, you are going to love this aspect of leasing: when you lease a product you do not pay sales tax the same way that you would if you were to outright purchase the exact same product.
Instead of paying the full tax amount up front, a portion of every monthly lease payment is paid for sales tax. In addition, you pay tax only on the dollar amount of the technology products and services value you are using, not on the residual value. Think back to the Time Value of Money, Capitalized Cost, and Residual Value concepts. Would you rather pay your full tax bill today or spread your payments over a specific term?
Security Deposit
The security deposit is usually equal to one monthly payment. Multiple security deposits can sometimes be made to reduce the interest rate and, consequently, the monthly payment.
Payoff Amount
Sometimes called buyout amount, this is the amount of money you have to pay to own the technology products and service that you originally chose to lease. The payoff amount might be different from the residual value because of a refunded security deposit.
Early Termination
If you are not happy with the products that you have leased, or you believe you will gain a lot of value by switching to a different product before your lease term is up, you may be able to start from scratch with an early termination of the lease. Be careful: this can be a useful tool, but it can also be very costly.
Depreciation
This is the amount by which property (in this case, some technology product or service) loses its value. In leasing, depreciation is the difference between the cost of the technology product when it is brand new and the value of the technology product at the end of the lease (plus tax, interest and various leasing fees).
As with residual value, software and technical/professional service have no depreciation because they are essentially worth $0 at the end of the lease.
Subsidized or Subvented Lease
To make a lease more attractive (i.e. make the monthly payment lower), manufacturers (OEM) sometimes subsidize or subvent the leases. This means that the manufacturer or OEM is either offering a very low interest rate or is inflating the residual value of their products. Both tactics have the effect of lowering the monthly payment for you, the consumer.
Excess Wear and Tear
Most lease contracts have a clause which states that the company leasing the technology products and service is responsible for the cost of "excess wear and tear" to the products when they are returned. Read your contract carefully to understand what is considered "excessive."
One extra step that may help you avoid having your security deposit revoked or incurring extra charges from the leasing company is purchasing end-of-lease servicing, which will bring your laptop back to like-new condition.
Gap Insurance
If you break your laptop beyond repair and/or it is stolen, there might be a gap between what your insurance company will pay you for the loss and the amount you now must pay to the leasing company. If you take out gap insurance (it is included in some lease contracts), this will cover you for this loss.
Money Factor
Pay close attention to this one. Your approved money factor will heavily influence the amount of your monthly lease payment. Also called a lease factor or even a lease fee, this is the interest rate you are being charged.
It is expressed as a multiplier that can be used to calculate your monthly payments. The money factor is calculated using a Present Value formula and is based on: the total dollar amount being leased, the lease term, your company's credit worthiness, your security deposit, and the residual value of the technology products and services that you intend to lease.
Thank you!
Thanks again for your time today. If you found this information useful, I invite you to read my future posts (upcoming topics are listed below) on leasing over the next several weeks.
I would love to know how leasing may affect your business decisions, and welcome you to leave comments and ask questions about topics you'd like to see addressed.
Focus on Leasing Topics:
- Leasing Vocabulary
- Financing Decisions
- Advantages of Leasing
- Capital vs. Operating Leases
- Understanding My Payment
- Picking a Lease Partner
- The OEM Lease
- Interest-Free Leasing
- Managing Lease Schedules
- Managing the End of Lease Process
Jeffrey Goldstein is Senior Consultant at MCPc and is responsible for the delivery of hardcopy and value-added services within the Lifecycle Management Group. Jeff earned his BS in Management of Information Systems and Supply Chain Management from The University of Akron and his MBA from the Weatherhead School of Management, Case Western Reserve University. Connect with Jeff on LinkedIn.
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