Business

Lease what depreciates – Buy what appreciates

Many years ago, the great John Paul Getty, who once held the title of being the world’s rich man, made the statement “Rent what you appreciate – Buy what you appreciate” as a basic philosophy that businesses should follow. prudent. Most of us in the leasing industry keep the statement in our arsenal as a method of convincing companies to lease their equipment.

But what does it really mean? Let’s break down the statement in its two components and see why it makes sense.

Firstly, “Buy what you appreciate” Simply put, it means owning assets that increase in value. Prudent entrepreneurs generally abide by the rule of increase that relates to continued growth. Revenue growth, company size growth, and net worth growth.

Very few assets that generate income and contribute to the growth of a business appreciate in value. For example, a piece of production equipment that costs $ 100,000 today may be worth just $ 60,000 or $ 70,000 a year from now on. In fact, the equipment can reduce costs by 20% and increase efficiency by 30%; however, if it is purchased outright, it will actually reduce the net worth of the business over time.

Assets depreciate at a pre-established rate that varies between 10% and 50%, depending on the class to which they belong. In year 1, the amount of depreciation falls under the 50% rule, which means that only half of the depreciation can be used as an expense. The net effect is a very slow depreciation for tax purposes and an erosion of the company’s net worth over time.

In second place, “Rent what depreciates”, refers to transferring ownership of any asset whose value decreases over time to a third party, also known as a financial leasing company. From an accounting point of view, leased equipment is considered a form of off-balance sheet financing, which means that it does not appear as a liability on the balance sheet. This accelerates the tax effect of a lease, since, if the lease is properly structured, payments are considered an expense and are paid 100% from day 1. Off-balance-sheet financing has the effect of improving financial ratios. , such as debt with equity, since the debt is not included in the balance sheet.

The business model of most leasing companies is one that is based on the addition of various assets to the financial statements, thus focusing on huge depreciation expenses. Leasing companies thrive by adding assets to their books and, in turn, fulfilling a great need for organizations to acquire assets.

One final note. Many companies have a strong propensity for owning equipment, a kind of pride of ownership. It should be noted that if your equipment purchase is secured by a bank loan or line of credit, you don’t really own the equipment until the final payment is made. In fact, they have the title to the equipment and show the depreciated value as an asset, but the equipment is not owned until the loan is paid in full.

Will companies acquire equipment through a loan? Absolutely. Will companies use leasing as a means of acquiring equipment? Absolutely. The purpose of this article is to take a closer look at the statement made by Mr. Getty many years ago, “Rent What You Appreciate – Buy What You Appreciate,” and look at the ways of acquiring equipment from a different perspective.

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