Many years ago, the great John Paul Getty, who at one time held the title of being the riches man in the world, made the statement, “Lease What Depreciates – Buy what Appreciates”, as a basic philosophy that prudent businesses should follow. Most of us in the leasing industry keep the statement in our arsenal as a method of convincing companies to lease their equipment.
But What Does It Really average? Let’s dissect the statement into its two elements and discuss why it make total sense.
Firstly, “Buy What Appreciates” simply put, method owning assets which increase in value. Prudent business people generally live by the Rule of Increase which relates to constant growth. Growth in revenues, growth in company size, and growth in net worth.
Very few assets which are revenue producing, and contribute to the growth of a company, appreciate in value. For example, a piece of production equipment costing $100,000 today, may only be worth $60,000 or $70,000 a year from now. The equipment may, in fact, reduce costs by 20%, and increase efficiency by 30%, however, if purchased outright, will truly reduce the net worth of the company over time.
Assets are depreciated at a pre-set rate ranging anywhere from 10% to 50%, depending upon which class they fall within. In year 1, the amount of depreciation falls under the 50% rule which method that only one half of the depreciation can be used as an expense. The net effect is a very slow write off for tax purposes, and an erosion of the net worth of the company over time.
Secondly, “Lease What Depreciates”, refers to shifting the ownership of any asset which decreases in value over time to a 3rd party, otherwise known as a leasing company. From an accounting point of view, leased equipment is considered a form of off-balance sheet financing meaning that it does not appear as a liability on the balance sheet. This accelerates the tax effect of a lease, as, if the lease is structured properly, the payments are considered an expense and are written off 100% from day 1. Off-balance sheet financing has the effect of improving financial ratios such as debt to equity, as the debt is not included on the balance sheet.
The business form of most leasing companies is one which is pushed by adding multiple assets to the financial statements, consequently being focused on huge depreciation expenses. Leasing companies thrive on adding assets to their books, and in turn fill a great need for organizations acquiring assets.
One final observe. Many companies have a strong propensity to own equipment – some sort of pride in ownership. It must be pointed out that if an equipment acquisition is secured by a bank loan or a line of credit, they truly do not own the equipment until the final payment is made. They do, in fact keep up title to the equipment, and show the depreciated value as an asset, but the equipment is not owned until the loan is paid out in complete.
Will companies acquire equipment using a loan? Absolutely. Will companies use leasing as a method of equipment acquisition? Absolutely. The purpose of this article is to take a closer look at the statement made by Mr. Getty many years ago, “Lease What Depreciates – Buy what Appreciates”, and look at ways of acquiring equipment from a different perspective.