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ABC Foundry needed to upgrade its melting equipment to meet the increased demand for truck replacement parts they are projecting to have in the next several years. The key equipment included two Power Supplies – 480 V input; two sets of high conductivity water cooled drop bars; two sets of Water Cooled Power Leads; two steel frame furnaces; a nonferrous closed pressurized water cooling system; and three electric cranes. Their total cost was $340,000.

In this example, management considered the options of equipment leasing, bank business loans or paying directly with cash.

Equipment Leasing vs. Cash

Due to ABC Foundry’s overall leverage, cash was not a viable option for financing its business. Even if it had the cash available, paying cash may not have been the right decision. According to a Dun and Bradstreet survey, the average company earns 15% on the money that is left in the business. Even if earnings were at 10%, the company is still better off using equipment leasing. Furthermore these examples don’t include the positive tax consequences of writing off the lease payments. Equipment leasing also provides a hedge against inflation and keeps cash available for tougher times. Paying cash requires paying for the equipment before it is productive.

Equipment Leasing vs. Business Loans

The management of ABC Foundry quickly dismissed cash as an option, then considered a business loan from a bank. The company had $300,000 available on its $500,000 credit line, and the bank was willing to restructure the relationship to include the business equipment loan with a 20% down payment.

The bank offered a five year 9% loan with a down payment of $67,484, the amount financed would have been a loan of $269,934 and monthly payments would be $5,605. The terms were favorable but the net result would stretch the company’s bank credit availability.

The Option Chosen for Financing a Business

After considering the alternatives for financing their business equipment, management decided to choose equipment leasing over business loans or cash. This allowed them to conserve the cash required for the bank loan down payment, and preserve the company’s bank borrowing capacity to support the company’s anticipated growth. The lease also gave them greater tax benefits.

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