How do equipment leasing companies make money? In such a highly competitive industry, it is very natural to wonder how equipment leasing companies are able to stay in business.
The most obvious means of making money include equipment sales, tax benefits and interest charges. To a naïve lessor, the less obvious ways of making money include upgrade financing, prepayment penalties, interim rent, equipment re-delivery charges, repair costs, filing fees, maintenance fees and re-marketing fees, just to name a few.
How Do Equipment Leasing Companies Make Money Through Interest Charges?
Financing profit, also known as financing spread is one of the most obvious ways that leasing companies make money. The greater the financing profit, the higher the interest rate charged. If for example, a leasing company borrows money at an interest rate of 12% per annum and charges a lease interest rate of 15%, then their financial spread would be 3% per annum. The equipment leasing industry is a multi-billion dollar industry and very competitive at that so many leasing companies often price their lease rates with little or no finance profit. This forces them to look for other means of making money, which brings us to the next point.
How Do Equipment Leasing Companies Make Money Through Tax Benefits?
In multimillion-dollar equipment leases, tax benefits available to leasing companies play a critical role in computing anticipated profits. Calculating transaction tax benefits is very difficult but the good news is technology has allowed the invention of analysis software that makes it much easier.
As the equipment owner, when the leasing company leases equipment, they have the right to claim equipment ownership tax benefits. Moreover, there are other tax benefits such as interest charges on loans for long-term equipment in the event that there are leveraged lease transactions. The lessee on the other hand will be entitled to deduct rent payments as a business expense but they cannot claim tax benefits on equipment ownership. Typically, when a leasing company lowers its rent, it can still realize a profit by taking into account equipment related tax benefits.
How Do Equipment Leasing Companies Make Money Through Residual Earnings?
When setting the lease rents, a leasing company’s main aim would be to have enough lease term rents to pay back any equipment loans, return equity investment, and make a profit with any sale made at the end of a lease. This is usually possible in small ticket transactions. If the transaction is a multi-dollar one, this would be rather impossible because of the highly competitive industry.
Other Ways That Equipment Leasing Companies Make Money
Most lessees prefer to sign a lease agreement that offers them the right to terminate their contract early due to a number of reasons such as not needing the equipment anymore or the equipment becoming obsolete. In such a case, the leasing company will charge the lessee an amount that is equal to a predetermined termination value. If the lease termination value is properly structured, it could be the perfect way to make a profit.
Leasing companies can make money when a lessee requests for an upgrade to the equipment they currently have or request for the lease contract to be modified. If the upgrade does not have a stand-alone value or is not readily removable, the leasing company will pay for the upgrade. In such a case, the lessee has two choices: to either buy the equipment with their own money or agree to the terms of the lease.
Excess Use charges
When equipment is returned in good condition, the end of lease sale profits will be much higher. One way that leasing companies can ensure that their equipment remains in good condition is to put strict guidelines on how to use the equipment. If the guidelines are not followed, the company can exert penalty charges, which can be paid at the end of the lease. The penalty charges are meant to make up for the reduced end of lease sales. Excess use charges can provide a great way to make profits.
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As you can see, equipment leasing companies can make money in a number of ways. This of course depends on the amount of money involved in the transaction, and the type of transaction.
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