MCPc Blog

Focus on Leasing: Financing Decisions

Now that we have the leasing vocabulary down, it's time to starting digging into how organizations make financing decisions for new IT projects. This week I will discuss a couple of basic ways in which most organizations evaluate IT purchases.

Example Exercise: Think About Personal Finance Decisions

Let's start with an exercise that will frame up our conversation. Pretend that you are in the mood to purchase a few new items from your local electronics store: a 70" plasma TV ($5,000), a Blu-Ray disk player ($200), and a Blu-Ray disk movie ($20). Note, in this example all of the items go on sale in different weeks, so you cannot purchase all three items at the same time.  This is a very wide range of prices, and having limited funds available in the ol' checking account to pay for such wonderful new toys, you have to weigh your options on how to best fund your new purchases. Here are your choices:

1) The electronics store is offering 24 months interest-free financing for purchases over $1,000

2) You have a personal credit card with a high limit

3) You can write a check and/or pay cash

With this information in mind, you decide that the best option is to:

• Use the 24 month interest-free financing option to purchase the TV. The purchase price of the TV plus 7.5% tax equals $5,375. That's approximately $224 per month for 24 months.
• Next, put the Blue-ray player on your credit card. That way you can save your $200 until your next credit card billing cycle, essentially deferring the payment a little. In the mean time you will collect a paycheck or two, allowing you to save up the $200 required to pay off your balance.
• Finally, simply pay cash for the $20 Blu-Ray.

Being the wise shopper that you are, you have just used your personal credit to finance your purchases. By appropriately spreading out the payments, and by managing your personal cash flow, you can now enjoy 70 inches of HDTV greatness. The payment methods you chose for Blu-Ray player and movie were far less complex, but still important.

Apply This Rationale to Business Decisions

Let's apply similar logic to your organization. Like to your checking account, credit card, and a 24-month financing option, your organization has a number of options when it comes to financing IT decisions. Being financially stable, your organization most likely has cold hard cash in the bank, as well as various existing credit lines with banks and other lending institutions. Your organization can also choose to open a leasing account, or can choose a "pay as you go" or "pay per use" option, essentially renting new IT products. 

So, what are the details of these common options for procuring new IT products, and what are their pros and cons?

Outright Purchase

When you purchase your new technology products and service outright, you assume full ownership at the time of purchase. There are two basic ways to finance your outright purchase: You can pay cash, or you can use one of the company's lines of credit. Once you make the purchase, your company will likely choose to either expense or depreciate the IT assets, generally determined by the dollar value.

Pros:

• You own the assets
• You get to squeeze every last drop of useful life out of the assets
• You can choose to expense or depreciate the assets, potentially giving you an accounting advantage

Cons:

• You just took cash out of the bank or leveraged a credit line to make the purchase
• You just paid the full sales tax amount for the purchase (unless you work for a school or non-profit)
• You may have limited ability to return the product and/or upgrade inexpensively

 

Leasing

Leasing is simply another type of credit line that is extended to your company by a bank or leasing company. There are two basic types of lease arrangements: Capital and Operating.  

Capital Lease

In a capital lease your organization assumes only some of the risks of ownership. The most important concept to understand about a capital lease is the word capital, as in cash or credit.  The accounting treatment of a capital lease is similar to an outright purchase. As the lessee you are obligated to report a capital lease as an asset and a liability on your balance sheet, and your organization can claim depreciation on the assets. 

Pros:

• Spread out your payment over the term of lease
• Sales tax payments are spread over the term of lease
• End-of-lease options include outright purchase of the residual or return to the lessor
• For a fee you can terminate your lease before the end of the term 

Cons:

• Considered an asset and a liability on your balance sheet
• Money factors and mothly payments are typically higher for capital leases vs. operating leases

Operating Lease

In an operating lease only the right to use the technology is transferred from the lessor to the lessee. The most important concept to understand about an operating lease is the word operating, as in operating expense. When leasing IT products and services, it is harder to qualify for an operating lease than a capital lease. Operating leases do not show up on your balance sheet.

Pros:

• Spread out your payments over the lease term
• Sales tax payments are spread over the term of lease
• Payments are treated as an operating expense
• Typically lower money factors and payments vs. capital leases

Cons:

• Harder to quality for an operating lease than a capital lease
• You cannot negotiate upfront for a end-of-term buyout price
• Early termination can be very expensive

 

Pay-Per-Use

In IT, pay-per-use is typically attributed to software as a service (SaaS) and copier/printer technology refresh projects. Pay-per-use models typically include a bundle of products and services. For example, a pay-per-use model widely used in the copier industry is cost-per-page. Your organization's cost-per-page may include fees for the lease or rental of the copier, toner, service, and maintenance for a specific term. 

Be aware that it is nearly impossible to compare a pay-per-use procurement option to a non pay-per-use. This is because pay-per-use procurement options are usually slightly more expensive than a typical lease or outright purchase, however they also come bundled with more value. 

Pros:

• Essentially a rental agreement that can be treated as an operating expense
• Flexible options to stop using the service (common of SaaS programs)
• You get a lot of extra value for the dollar

Cons:

• You always have a payment
• You never get to own the product, only use it
• Can be difficult to compare to more traditional procurement models

Just like with personal financing, when your organization is procuring new technology products, understanding the options available can help you make smarter purchase decisions. What options have you taken advantage of in procuring new technologies? How have they worked out long-term? 

Spotlight on Leasing Topics:

1. Leasing Vocabulary
2. Financing Decisions
3. Advantages of Leasing
4. Capital vs. Operating Leases
5. Understanding My Payment
6. Picking a Lease Partner
7. The OEM Lease
8. Interest-Free Leasing
9. Managing Lease Schedules
10. 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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