Leasing options can help you to reserve your working capital, manage your credit, and still invest in the equipment your small business needs to pursue its growth targets. Tracking industry trends for 2015 can help you make the right leasing decisions for your company. In addition, you’ll want to learn more about planned changes to accounting rules that will alter the way equipment lease expenditures are reported. These 2015 industry trends and changes in accounting rules can help you assess your company’s equipment leasing options
As a small business owner, you can’t afford to have cash management concerns distract you from your company’s core areas of focus. At the same time, you need to conserve your working capital and make the most strategic use of your lines of credit as you pursue new opportunities in areas such as marketing, R&D, and expansion. And to complicate matters further, you need to invest in equipment to keep your company competitive and positioned for growth. Depending on your needs and objectives, leasing may make sense for your company when the time comes to acquire new equipment.
According to the Equipment Leasing and Financing Association (ELFA), that time may be now. The organization predicts that 2015 will see record spending of “nearly $1.5 trillion in capital goods or fixed business investment (including software).” That figure accounts for spending by U.S. businesses, nonprofits, and government agencies. On the business side, the hike in spending is seen as a sign of economic confidence and expectations of expansion, as companies in some industries see capacity utilization rates “reach or surpass levels historically known to spur business investment.”
2. Taking stock of the industry trends
ELFA predicts a “healthy growth rate of 6 percent” in equipment and software investment this year. It adds that “aircraft, trucks, and other industrial equipment are projected to be among the higher growth types, while agriculture, computers, and software are expected to see slower growth.”
With the Federal Reserve expected to raise short-term interest rates in 2015, the organization predicts that businesses will “seek to lock in equipment financing at lower rates.” In fact, it has forecast a trend toward the use of financing for 62 percent of businesses’ $922 billion in expenditures on plant, equipment, and software this year.
Technological advances are supporting the move toward increased financing. “Equipment finance providers are streamlining their business processes and improving customer self-service capabilities using digital technologies,” ELFA finds. “To meet customer demand and address evolving technology equipment requirements, equipment finance companies will tailor innovative financial offerings.”
3. Taking reporting rule changes into account
In addition to tracking these 2015 trends, ELFA has its eye on an upcoming change in accounting rules that will have an impact on the way businesses account for equipment leases. Lease consultant Bill Bosco of Leasing 101, a member of the ELFA accounting committee, was sponsored by the organization as a working member of the Financial Accounting Standards Board (FASB) task force to change the accounting rules. He explains that the Lease Accounting Project was initiated by FASB, which establishes accounting rules in the U.S., at the direction of the Securities and Exchange Commission.
“The project’s major objective is to record operating leases as an asset and a liability on the balance sheet of any company that has to report audited financial statements,” Bosco says. “So it’s going to apply to small- and medium-sized enterprises that have to put out audited financial statements for their banks. The objective is to show readers of financial statements what the liability was for operating leases as well as what the value of the right to use the asset is that arises from those operating leases.”
The project began in 2006, and to understand its evolution, it’s helpful to have some background on where accounting rules and practices stood at that starting point. “Operating leases are currently off balance sheet, and what that means is that neither an asset nor a liability appears on the books, but a company reports rent expense,” Bosco explains. “They accrue the average rent, and they pay the actual rent for any equipment that they’re leasing or any office space or retail store space.”
Under that practice, financial statements record only rent expense, and companies footnote future rent obligations, he adds. “That’s so people like lenders can understand what your company is obligated for that might not be on the balance sheet when they’re making a decision as to
whether or not to lend you money.” The SEC decided that it was better practice to include that information on the balance sheet, and that decision led to FASB’s creation of the Lease Accounting Project.
4. Scaling the changes to small business capacity
The details of the initial proposed change sparked concern among small business owners and leasing industry professionals. “People were worried about the complexity of this,” Bosco says.
“A small business doesn’t have a big accounting staff.” But the project has evolved through many iterations and much public comment since its inception, and based on industry input and public comment, FASB opted for a rule that puts the present value of rents on the balance sheet as an asset and a liability but does not call the liability debt.
“That’s an important point. They made it easier to comply because of the way they decided to handle the P&L and the balance sheet,” Bosco says. “The P&L is going to stay exactly the same. A small- or medium-sized company, or any company for that matter, would for operating leases approve the average rent expense if it’s an uneven rent lease, and pay the actual rent expense, same as you do today—so you don’t have to change your rent payment process or your rent cost accounting process.”
Another area of concern was that the new rule would have a negative impact on small companies’ credit ratings, but that fear is unfounded, Bosco says. “Your credit is not going to change at all, because lenders and credit rating agencies always look at operating leases in the footnotes. Just because FASB says you’ve got a new asset and liability doesn’t change your ability to pay your debts, so your credit rating isn’t going to change.”
5. Getting a handle on it all—and preparing for compliance
What does the impending change mean, in practical terms, to you as a small business owner? When the new rules go into effect, you’ll “put the present value of the lease on the books each month with the new present value and reverse the old present value,” he says. “You can actually do it on an Excel spreadsheet. All you’ve got to do is put at the head of the column a present value calculation using your incremental borrowing rate, which is the rate that you’d pay on a loan of the same term as the lease. Put that at the top of the column, do a PV calculation, and make an entry debiting right-of-use asset and crediting other lease liability. It’s that simple.”
In its latest iteration, which is supposed to be signed toward the end of this year, the rule “will give users of financial statements better information, but it will not penalize companies that are leasing equipment as the original project would have,” Bosco says. He notes that the FASB made a great effort to simplify the accounting changes prompted by the new rule and to make compliance less costly.
It’s also important to remember that the new rule will not go into effect for companies until 2018, so you’ll have time to prepare for the change. But by educating yourself about the new rules now, you’ll be better equipped to understand the full impact of your equipment leasing decisions. And that, in turn, will help you to devise your most productive and profitable strategy for investing in your company’s long-term growth and success.
The ELFA maintains the Equipment Finance Advantage website, which offers a variety of resources for small business owners:
If you’re new to equipment leasing, these ten questions help you evaluate your options and assess the financing terms you’re offered. http://www.equipmentfinanceadvantage.org/10qs.cfm
This chart provides a point-by-point comparison of leases versus loans.http://www.equipmentfinanceadvantage.org/ef101/llc.cfm
Refer to this online glossary when you need assistance understanding terminology used in the lease agreements you’re offered. http://www.equipmentfinanceadvantage.org/ef101/glossary.cfm
This Digital Toolkit not only reviews the basics of equipment leasing, but also explains how it can work as part of your asset management strategy. http://www.equipmentfinanceadvantage.org/Toolkit/
Wondering which trends the equipment leasing industry is tracking this year and how these developments might affect your small business? This article provides an overview of what to watch.
Time Value Software created this equipment lease rate calculator to help evaluate your leasing costs.
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