Page 202 - Finance for Non-Financial Managers

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Financing the Business
loans secured by stable collateral and lower than loans with
greater risk, like factoring.
Payments are structured to provide principal and interest 183
with a level payment each month. That means, of course, that
earlier payments are mostly interest with little principal reduc-
tion. (Have you ever looked at your home loan statements a
year or so after buying or refinancing? You’re not paying much
principal, are you?) The level payment makes repayment man-
ageable for the borrower, but the downside is the low rate of
principal reduction until late in the life of the loan. One option:
shorten the life of the loan. Principal reduction is increased in
shorter-term loans and interest cost is correspondingly
decreased.
A variation on the equipment purchase loan is the equipment
lease. The cash management objective is the same, but the
money is often easier to find because the lender/lessor has a
stronger hold on the collateral until the company has paid the full
amount of the loan. In an equipment purchase, the lender has a
lien on the equipment, but the borrower actually owns the equip-
ment. Thus, legal action in the event of default is somewhat
involved. By contrast, under a lease agreement, the equipment
lessor, not the borrower, owns the equipment. The lessor remains
the legal owner until the lease obligation has been satisfied in full
and the lessee either purchases the asset or returns it to the les-
sor. Collection action is simpler in event of default. Risk is less,
making a lease often easier to obtain than a purchase loan.
The cost of equipment leasing will typically be higher than
the cost of an equipment purchase loan, if for no other reason
than there’s usually an intermediary (the lessor) between the
buyer and the seller. This cost comparison rule-of-thumb is not
always valid because there are other considerations that affect
cost. Tax benefits that can accrue to a lessor who continues to
own the equipment, benefits that might be partially passed
through to the lessee/borrower, can result in lower net lease
rates. But companies looking into leasing should do their home-
work before they take that to the bank.