In the past the legendary John Paul Getty, who was once the title of being the wealthiest man on earth was quoted as saying “Rent what is going down Buy what goes up,” as a basic idea that every company should adhere to. The majority of us working in the leasing business have a copy of this statement to use to convince businesses to let their machines.
What does it really mean? Let’s break it down into two parts and then discuss the reasons the reasons why it is logical.
First foremost “Buy the things you love” simply put, it is the act of acquiring items that increase in value. The most prudent business owners typically adhere to the rule of growth that is a reference to continuous growth. Increase in revenue, company size increase, plus net worth increases.
A small percentage of assets that generate revenue and aid in the development of the business are worth more than they were before. For instance, a piece of equipment for production that costs $100,000 today might be worth $60,000 or $70,000 in the future. Actually equipment could cut expenses by 20 percent and boost efficiency by 30 percent however, if it’s purchased for cash it could actually decrease the capital of the business over time.
Assets are amortized at the pre-determined rate of 10 percent to 50%, based on the class that they are part of. In the first year the amount depreciated is subject to 50 percent rule meaning that only half the depreciation could be utilized as an expense. The result is a slow write-off of the expense for tax purposes as well as an increase in the value of the company as time passes.
Second, “Renting something that decreases in value”, refers to the transfer of ownership for any asset that’s value decreases with time to an unrelated party, also called a leasing company. From a financial perspective leasing equipment is as an off-balance-sheet financing, which means that it is not reflected as an expense in the balance sheet. This boosts the tax benefits of the lease, since when the lease is structured correctly, the lease payments are regarded as expenses and are tax-deductible 100% beginning on the first day. Off-balance-sheet financing is a great way to enhance financial ratios for example, debt-to-equity. it is not reported as a balance sheet item.
The business model of the majority of leasing firms is based on adding multiple assets to their balance sheets, which highlights the large amount of depreciation expense. Leasing firms thrive when they add assets to their accounts and, in turn, fill an enormous need for companies who purchase assets.
One last note. Many businesses have a tendency to own equipment, as a form of pride of ownership. It is important to remember that if an item is secured with an unsecured loan from a bank or credit line, they are not actually the owners of this equipment till the full payment has been made. The equipment is actually theirs and can show the depreciated amount as an asset. However, the equipment isn’t actually in the hands of the lender until it is fully paid.
Do businesses buy equipment using credit? Undoubtedly. Do companies consider leasing to purchase equipment? Undoubtedly. The aim for this post is to look at an in-depth look at Mr. Getty’s quote from many years back “Rent the depreciating stuff – buy the things that appreciate” and to look at methods to purchase equipment with a new perspective.