Before entering into any equipment lease schedule, a lease versus buy analysis should be conducted to ensure that leasing is indeed the most cost-efficient procurement option.
First it’s necessary to analyze historic leasing costs in order to accurately project future leasing costs, which can then be compared to the cost of purchasing. An incomplete analysis of historical leasing costs won’t do. All the past costs must be included, not just the sum of rent payments
To be effective in comparing the two options, the lease versus buy analysis must identify and measure past performance related to these five critical leasing costs, each of which can have significant impact on the results of a lease versus buy analysis:
1. Early-lifecycle fees and recurring costs.
Many lessors seek to collect substantial fees before the lease term begins, including interim rent, retainable deposits, and commitment fees. Equipment lease agreements also frequently include recurring service fees, such as for restocking and documentation.
Identifying these costs requires review of all original lease documentation, invoices, accounts payable reports, and other pertinent data sources.
2. Extensions and Renewals.
Lessees end up paying extension rents so frequently that many lessors include extensions in their pricing calculations. Extensions, lease renewals and rolls, and other forms of continued payments are lessors’ primary source of profit—so it’s imperative to track the historical costs of extensions and renewals.
To do this, an enterprise must crosscheck the original lease documentation with lessor invoices and accounts payable reports. It’s important in this process not to overlook partial extensions, which can add considerable cost.
3. Transition Costs.
A “transition term” is a period (typically one to three months) after the end of the regular lease term during which the lessor replaces the equipment with new equipment, which is covered under a new lease schedule.
During this transition period, the lessee generally isn’t required to pay interim rent on the new schedule, and for this reason, some accounting departments have excluded transition costs from their lease versus buy analysis. This is a big mistake, because the transition payment is usually a required payment, and many lease agreements are structured so that it requires nearly flawless timing on the part of the lessee to avoid the interim rent on the new lease schedule.
4. Asset Purchase.
Many leases provide buyout options at the end of the lease, but they are often structured so that the buyout price is far from “fair market value,” even if that term is used. Buyout valuations of 40-50 percent of original equipment cost are common, even if the equipment has little or no street value.
Accurately identifying and measuring the historical extent and context of these costs involves a meticulous review of closing documentation for leases, relevant invoices, and sometimes even email trails.
5. Damage Charges.
Damage charges are far from trivial, but they are difficult to track. This is largely because damage charges can vary considerably between lessors and asset types. They are also closely tied to the operational limitations of the lessee.
To project future damage costs, it’s necessary to go over all invoices and then establish a baseline of damage costs as a percentage of OEC for each asset type and lessor.
Conclusion
A lease versus buy analysis will only be effective if the historical all-in costs of leasing are quantified for use in projecting future leasing costs. But this complex analysis is difficult and often beyond the means of lessees. In such cases, outside leasing experts can apply their knowledge to aggregate and analyze the data.
