John Paul Getty, a one-time title holder of being the richest man in the world, advised people a couple of years ago to lease those that decrease in its value and buy only assets that increase in value. He considers this statement an underlying philosophy that wise businesspeople must follow. If you work for the leasing industry, you use this statement to convince companies to lease your equipment.
What is the real meaning of this statement, though? Let’s divide it into two parts and learn further why it perfectly makes sense.
The first part is ‘buy assets that only increases in its value.’ This part means that you should only buy assets that increase in value. The rule of increase guides sensible business people, which is associated with continual growth: growth in company size, growth in revenues, and growth in net worth.
There are only a few assets that contribute to the growth of a company and in revenue, which increase in value. For instance, a piece of production equipment may cost $100,000 today, but a year after may only be worth $70,000 or $60,000. This equipment may increase efficiency by 30% and reduce costs by 20%, yet if bought upright, it will reduce the company’s net worth over time.
Assets generally depreciate at a pre-set range between 10% and 50%, depending on the class they fall in. In the first year, the decrease in value can fall within the 50% rule, meaning you can use half of the decrease in value as the expense. For tax purposes, the net effect is a very slow write-off.
Now, the second part is ‘lease those that decrease in value.’ This part implies shifting the ownership to a third party or a leasing company of your asset that decreases in value over time. From an accounting viewpoint, leased equipment is considered one type of off-balance-sheet financing. What this means is that it will not appear as a liability on the balance sheet. The tax effect of lease accelerates. When the lease is appropriately structured, the payments are taken as an expense and are written off a hundred percent from the first day. You can improve financial ratios like debt to equity with off-balance-sheet financing because debt is no longer part of the balance sheet.
The majority of leasing companies make use of a business model that is driven by adding many assets to financial statements. So, it is more focused on more significant depreciation expenses. Leasing companies perform better when they add assets to their books. In turn, they help fill the need of companies to acquire assets.
Finally, a lot of companies have a strong inclination to own equipment as some form of pride of ownership. However, there is one thing you should know if your company does this. If a company owns equipment with the help of a line of credit or a bank loan, for instance, it does not truly have ownership of the equipment unless they make final payment to it. Of course, the company still holds title to the equipment and show its depreciated value as their asset; however, the equipment is never truly owned by a company until they pay the full amount of the loan.