To lease or not to lease, that’s the question that impacts business decisions most. However, the IFRS 16 standard may also have real-world implications.
IFRS 16 is the standard that reduces the accounting distinction between investments and leases. Therefore, a narrow interpretation of the question in the headline can easily be answered by saying that IFRS 16 has little if any impact on business decisions.
However, we choose to see the question from a broader perspective. Starting with the question of whether a company's properties, transport vehicles, and major equipment should be purchased or rented/leased, the answer changes significantly.
How much is flexibility worth to the business?
The big questions continue to be: Own or lease/rent? Tie up a lot of capital with relatively low flexibility in interest cost/opportunity cost? Or tie up less capital, have more flexibility, and instead pay a little more each month?
The consensus in the business world's finance departments is approximately as follows: The choice between leasing and purchasing equipment can have a profound impact on a business's
- financial health
- operational flexibility
- strategic focus
- long-term planning
How does it affect business decisions that the company chooses rental/leasing instead of buying equipment, machinery, and property? We will look closer at this in this article.
Investing: Purchasing cars, machinery, and real estate
Let’s start by looking at some of the effects of purchasing assets, and indicate the effects it may have on business decisions.
Capital expenditure (CapEx) is the main keyword when choosing to purchase assets instead of leasing them. Buying results in a significant upfront capital expenditure, impacting cash flow and reducing liquidity in the short term.
Buying is thus a long-term financial commitment. Also, it is a more long-term technological commitment: Buying (more often than not) locks the business into specific assets and technologies.
Flexibility and obsolescence are limitations that need to be considered: Compared to leases, there is normally less flexibility to upgrade or change equipment, and the company bears the risk of asset obsolescence.
Resale value, however, is among the prospects of ownership: There's potential for an asset to have a resale value at the end of its useful life, while this is not relevant if equipment is leased.
Leasing: Flexibility for growth and the need for scalability
In many ways, leasing assets is the mirror image of choosing to purchase.
Leasing normally improves cash flow since it requires less upfront cash compared to purchasing. Leasing can thus be particularly beneficial for businesses with limited capital as well as those that prioritize maintaining liquidity.
This could influence decisions related to working capital management and investment in other areas of the business. Leasing requires less upfront investment, preserving capital for other uses.
Just as importantly, leasing provides more flexibility, as it allows businesses to upgrade or change equipment more frequently without the burden of ownership. This can impact decisions around technology adoption, scaling operations, or adapting to market changes.
Leases often include maintenance, reducing the burden on the company's resources. Also, the risk of asset obsolescence is typically borne by the lessor, not the lessee.
To lease or not to lease, that’s the question
The choice between buying and leasing has wide-ranging implications on a business's financial statements, cash flow management, strategic flexibility, and operational decisions. There are several questions to consider to find out what is best on the balance.
- Cash flow effect: Leasing may offer smoother cash flow, while buying could lead to significant initial expenditure. What is most important to your company now and in the coming years?
- Strategic flexibility: What are the company's strategic goals, including growth plans and operational flexibility?
- Technological advancements: For rapidly evolving technology, leasing might be more beneficial to keep up with the latest advancements. What is your company’s road map?
The best choices depend on the company's financial health, strategic goals, industry dynamics, and the specific terms and conditions of the purchase or lease agreement.
IFRS 16 and business decisions – yes there may be one impact
IFRS 16 does impact quite a few financial ratios, as we lay out in this article. However, the standard does hardly impact the running of the business as such.
One possible kind of business impact has to do with lending. The change in reported EBITDA, debt and assets may affect loan covenants, borrowing capacity, and investment decisions. Companies may need to renegotiate terms with lenders or adjust their financing strategies.
Implementing IFRS 16 also requires changes to accounting systems and processes to track and report on leases accurately. This could require investments in technology and process redesign.