Nearly half of all listed companies lease equipment, but the previous standard of lease accounting failed to reflect truly the economic status of businesses.
More than three trillion dollars’ worth of leases is outstanding (around the world), and - currently - operating leases are not shown on the balance sheet, which means a large chunk of the liability of every company is not visible to investors.
Educated investors make their own adjustments by multiplying the yearly lease payments by about seven or eight times, but sometimes they overestimate the lease liabilities, whilst those investors that don’t adjust the numbers can be misled. But with standards changing what are the benefits of leasing for the retail industry, for example, going forward?
Here Are The Benefits Of Leasing For The Retail Industry:
Many business leases come with 100% financing, which means no money down. This all-in financing allows for businesses to keep their generated cash in their pockets with an agreed upon payment each month. So, while payments can be made from future cash flow, they can lease the equipment immediately- equipment which will often generate that future cash flow.
If you plan to replace your assets frequently, such as refreshing tills for iPad checkout, for example, then you can outsource obsolescence. When you lease, rather than purchase, equipment, it can be replaced with the most current and faster models, enabling you to stay ahead of the competition.
If you own an asset, for example, a car, when you want a new one, you must find a buyer for the old asset. The same goes for retail, but when you lease items, once the lease is over, the asset returns to the lessor and the equipment is no longer the problem of the lessee. With retail leasing, these terms allow for a better cash flow since you don’t have your money tied up in old investments that don’t bring returns.
Companies can take advantage of the tax benefits associated with leasing. Lease payments can reduce taxable income in a more appropriate way than when you have a depreciation expense. If you treat operating leases like rentals, you can expense the lease payment when the business makes it, giving you a tax advantage. In many cases, leasing allows businesses to have a full deduction of lease payments against current earnings.
Cash Flow Control
When you lease equipment, you can save any working capital (bank finance lines) for any day-to-day business costs, expansion, or any other business-related expenses. When you save your working capital, you have a pre-set monthly line item that helps you budget efficiently. You will have more predictable monthly expenses, allowing for long-term growth plans. Cash flow can be managed for other expenditures. If you own equipment, on the other hand, it may unexpectedly break or have to be replaced, wiping out a positive cash flow. With leasing, you’ll always know what and when you’re going to pay.
Cleaner Balance Sheet (for now)
Since monthly lease payments are viewed as a business expense and not long-term debt, your balance sheet will look more attractive; however, IFRS 16 will mean that you do have to report the committed expense on the balance sheet, but it’s up to investors to determine if that balance is a detriment or an asset to operating costs.
Healthy Business Credit
When businesses lease instead of buy, it keeps traditional credit lines open. For example, on a personal level, if you take out ten credit cards, when you go to take out the eleventh, you most likely will not be allowed to because your expenditures are more than your income - or you’ll perhaps be subject to an astronomical interest rate; however, if you lease most of your equipment and have saved capital, your credit lines will remain open with the banks for when you do need to purchase assets or expand your company in some way.
Getting a loan for expansion, staffing, and other expenses requires a solid credit report, and keeping the lines open means you will have it available and unused when you need it.
As you can see, leasing provides many benefits to the retail industry - and many other industries - which is why many businesses choose to have operating expenses rather than reducing their capital by owning absolutely everything. However, since changes and new rules are being implemented soon, make sure you understand how your leases can be affected.
Reminder: IFRS 16 Is Changing Things
With the new IFRS 16 accounting standards, all leases - finance and operating – will go on the balance sheet with the exception of shorter leases under one year, and small ticket items like office furniture and iPads, for example. The new accounting standards mean that investors will get a better view of all lease liabilities and not just the finance leases, which allows for better transparency.
During the financial crisis, many retail companies went bankrupt, but they had clean balance sheets with few debts showing; however, they had many invisible leasing liabilities. With the new standards, investors can make better comparisons between companies and understand their financial liabilities and how they are performing against them.
For example, many airlines that buy their aeroplane fleet pay on finance, but other airline companies lease their fleet. They may have similar financial obligations in terms of payments, but with the current practice, the company that owns the aeroplanes has debt on the balance sheet, but the airline that employs operating leases enjoys a clean balance sheet. There’s no way to compare them accurately, and that’s quite unfair.
The most affected industries will be airlines, retail, and shipping, but almost fifty percent of companies worldwide will be affected in some way - since that’s how many companies use leases to remain operational.
The new standards may not be met with enthusiasm by companies unlike by investors, but leasing is still an attractive option for businesses, even with the upcoming changes.
How Can You Prepare For IFRS 16?
Make sure to download a FREE copy of the 7 steps to new lease accounting compliance so you’re prepared early. Putting everything on the balance sheet will give your retail business a realistic understanding of assets, operating costs, cash flow, and expenditures overall, so long term it’s a great idea. But it takes a while to get compliant so start today.