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Should You Lease or Buy? One of the main attractions of leasing is the idea that your leased equipment can earn money before you actually have to start paying for it. Your new console or PA rig "pays for itself." Look at the diagrams below, which show a very simplified model of the way cash flows into and out of a business. If you buy equipment, "you have to spend money to make money." That is, your process starts with the outlay for capital equipment. You continue to spend money to perform your operations: making goods, providing services, or some mixture of both. Only after both those outlays do you have the opportunity to write an invoice and generate income. Note that while cash flow volume is essential to the long term growth of a business, cash flow velocity is often more critical to short term survival. This is especially true in a growth phase, because your outlays (negative cash flow) for supplies and operations are expanding ahead of your receipts from sales (positive cash flow). You can easily find yourself in diagram #3 during a period of rapid growth, or in an economic slowdown when your customers begin to "slow pay." This is the problem that leasing could solve. But it's not a magic bullet. The "time value of money" comes into play when we try to accelerate cash flow by borrowing. "I'll gladly pay you Wednesday for a hamburger today," Oliver Hardy once said. All well and good, but when you have to pay for a hamburger, fries and a shake on Wednesday in order to get a hamburger today, you may find yourself even closer to starvation on Thursday. |
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Healthy profitable business: the volume of the cash flow from customers is greater than the sum of supplier payments and internal operations costs, and its average velocity is at least as great the velocity of the outgoing cash flows, so we seldom miss out on those prompt payment discounts. In addition, the volume of the loop will increase over time. |
Unprofitable business: the volume of cash flow returning from customers is smaller than the outgoing cash paid to suppliers and to the cost of operations. (In the diagram above, the area of the black arrow is smaller than the combined area of the two red arrows.) If this keeps up, all the cash will flow out of the loop to suppliers or "evaporate" in cost of operations. A simple example of the time value of money: see how delaying a payment affects its value. |
Cash flow crunch: The average velocity of cash flowing into the business from customers is less than that of the cash flows to suppliers and operations. The loop is in danger of being broken even though the volume of incoming cash would be sufficient to meet the needs of the business, if it arrived in time. If the volume of the incoming cash flow is sufficient, we can borrow against it and use the borrowed money to bridge the gap between receivables (black) and payables (red, just like they do it in the accounting ledgers). Since it costs money to borrow money, this effectively reduces the volume of the incoming cash flow. Be careful that the cost of capital (equipment, raw materials or operating capital) does not put you in position #2 ("too little"), instead of #1 ("healthy cash flow") as it is intended to. |
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