Lease vs Buy – Net Advantage to Leasing Calculation

Business woman giving thumbs upThe lease vs buy decision involves many factors including the financial analysis to determine the net advantage to leasing. Overall the lease vs buy decision hinges on a decision of owning or not owning the asset and a decision on how to finance the asset acquisition.

Types of Leases

The factors affecting the lease vs buy decision and the basics of leasing were detailed in an earlier post on the lease vs buy decision. In that post I describe the three main types of  leases but focus mostly on the differences between operating leases and capital leases.

The reason for focusing on operating leases and capital leases is they are the most common and each have different advantages on the business case through their financial treatments.

But there is another lease classification often overlooked by CIO’s considering the lease vs buy decision. This classification relates to who is responsible for several key responsibilities and expenses on the asset which are:

  • Full-service lease: Lessor responsible for maintenance, insurance, and property taxes.
  • Net lease: Lessee responsible for maintenance, insurance, and property taxes.

As you can imagine the difference between a full-service lease and a net lease on the total cost of ownership (TCO) might be significant and even change the lease classification from operating lease to capital lease further impacting the net advantage to leasing.

Net Advantage to Leasing

Net advantage to leasing (NAL) is a standard financial analysis used to determine if it is financially better to lease something rather than borrowing money to purchase the asset. The result of the financial analysis is the amount of money an organization will save (lose) if they lease vs buy an asset. In general organizations will choose to lease vs buy if the net advantage to  leasing is positive.

Calculating the Net Advantage to Leasing

Many CIO’s make the mistake of using an overly simplistic financial analysis for the net advantage to leasing to support a lease vs buy decision by comparing only the purchase price to the sum of the lease payments. So an option to lease a new SAN for $40,000 over 5 years might seem to be advantageous to purchasing it for $250,000. Some might also be tempted to use a simplified net advantage to leasing formula.

But to truly determine the net advantage to leasing CIO’s need to compare the net present value of purchasing to the the present value of leasing in much more detail because there are several other financial considerations which must be accounted for.

These considerations are the result of the differences in how capital purchases and leases impact cash flow, income statements and the balance sheet. For example, the depreciation from a purchase is posted as an expense which can lead to lowering taxable income but there are also usually maintenance and repair expenses and property tax liabilities.

NAL = Present Value of Purchasing – Present Value of Leasing

Calculating the net advantage to leasing simply requires CIO’s or project sponsors to use the ROI calculator I have provided to develop the net present value if the asset(s) is purchased and also for leasing the asset(s). The results of the two ROI calculators can then be compared for the net advantage to leasing.

Lease vs Buy in the Public Sector

Public sector CIO’s, and those serving non-profits, will find the lease vs buy decision to be a bit more straightforward. This is because the tax implications are not a factor. Similarly, the lower rates typically seen by municipalities for borrowing means their cost of cash is lower than corporate rates might be. For these reasons, public sector CIO’s will notice differences in the result of their net advantage to leasing calculations not seen by corporate CIO’s.

For many public sector CIO’s the issue driving the lease vs buy decision is often not the decision on asset ownership or the decision on financing the acquisition based on the net advantage to leasing. Instead the decision hinges on limitations in their operating budgets versus capital funds. Don’t make the mistake of simply thinking this is the just the Capex vs Opex issue since the net advantage to leasing may more often dictate leasing instead of a capital purchase when the reality of today’s operating budgets won’t allow it.

This entry was posted in IT Financial Management and tagged , , , . Bookmark the permalink.