For an Indian MSME business, getting new machines to improve their business could be difficult due to lack of sufficient finance/cash flow. While saving up for an outright purchase might be ideal, it can stifle growth and delay important projects. In such cases leasing out machines and as an alternative getting a machinery loan could be 2 different options to look at. Both options allow you to access the machines you need without affecting your existing working capital. But how would you decide which one is right for your business?
Understanding Machinery/Equipment Leasing
Equipment leasing/ Leasing of Machinery works more like a long-term rental agreement. You select the machine which you need and sign a lease contract with a leasing vendor. In return for a fixed monthly payment, you will get the right to use the machine for an agreed period. At the lease end, you typically have three options:
- Return the Machine: This is the most common option. You can simply return the machine to the vendor who gave out the machine given that you are returning it in the same condition in which it was originally given to you.
- Buy the Machine: Some contracts allow you to buy the machine at a price which is agreed on contract creation, allowing you to own the equipment after the lease term. This could be useful if you found the machine to be profitable for your business, many business owners take this option as the risk factor is much less. Considering issues like inflation and chances of cost of machines going up due to changing economic conditions/budget changes which are beyond your control it could turn out to be a good clause to have.
- Machine Upgradation: Certain lease contracts would allow the MSME owner to get an upgraded version of the machine at the end of the lease period.
Advantages of Equipment Leasing for MSMEs
- Lower upfront costs: You wouldn’t need to pay high down payment amounts unlike a machinery loan, which usually needs to have a down higher down payment amount.
- Predictable monthly payments: Leasing offers fixed monthly payments throughout the lease term, making budgeting and cash flow management easier.
- Tax benefits: In India, lease payments are considered operating expenses, which can be tax-deductible.
- Access to cutting-edge equipment: Leasing allows you to upgrade to newer equipment at the end of the lease term, ensuring you always have access to the latest technology.
- Preserves working capital: By leasing instead of buying, you free up your working capital for other business needs like inventory or marketing.
Disadvantages of Equipment Leasing for MSMEs
- No ownership: At the end of the contract period the MSME wont be having ownership to the leased machine, unless there is buying trigger already mentioned in the signed contract due to negotiation/pre agreed terms.
- Potentially higher overall cost: While monthly payments might be lower, leasing can be more expensive than financing in the long run, as you’re not building equity.
- Limited customization options: You might have less flexibility in modifying or customizing leased equipment compared to owned equipment.
- Early termination penalties: Breaking a lease early can result in hefty penalties.
Understanding Equipment Financing
Equipment financing/Machinery Loan is a loan which you take out to buy a machine. You make fixed monthly payments to the lender, with the ownership of the equipment transferring to you upon full payment.
Advantages of Equipment Financing for MSMEs
- Ownership: You become the legal owner of the equipment after completing the machinery loan payments. This allows you to have full control over it where you can keep it, sell it, or even use it as a collateral for future loan applications (however NBFC lenders could give you a loan without giving collateral).
- Potential for lower overall cost: In the long run machinery loan could be a better option as each monthly payment increases your stake in the machine , so month over month you increase the hold/ownership and brings you closer to actually owning the particular machine/machines.
- Greater flexibility: Unlike a lease contract you could make changes to the machine as per your unique business needs, which allows you to play around and configure the machine as per your business needs. This is very important for most manufacturing businesses.
- Builds business credit: Your business’s credit score/credibility also increases as you keep paying the unsecured business loan on time this also increases your chances of getting more loans approved easily in the future.
Disadvantages of Equipment Financing for MSMEs
- Higher upfront costs: The first payment also known as the down payment can be a higher sum and could be difficult for a small business to pay upfront.
- Risk of default: As much as it can have a positive impact on your credit score on payments on time, not making payments on the assigned dates could negatively affect your credit scores as well.
- Longer approval process: Getting a machinery loan could also consume time, most financial lenders like banks do a lot of background checks before approving a loan, so it would be better to approach an NBFC lender to reduce the turnaround time.
Why Equipment Financing is a Better Option for Most MSMEs
While equipment leasing offers advantages like lower upfront costs and access to new technology, for most MSMEs, equipment financing presents a more strategic long-term solution. Here’s why:
- Focus on Ownership: Building equity in essential equipment strengthens your business’s financial foundation. You can leverage the equipment as collateral for future loans, sell it if needed, or benefit from depreciation tax advantages.
- Long-Term Cost Savings: Though monthly payments might be initially higher, financing allows you to own the equipment outright, potentially saving money compared to leasing over the long term.
- Greater Control: Owning the equipment gives you complete control over its use, maintenance, and potential modifications.
Making the Right Choice
Ultimately, the best option – leasing or financing – depends on your specific business needs and financial situation. The best option would be a machinery loan and if you are an MSME approaching an NBFC would be ideal for you since NBFCs are catering in particular to MSME customers and have packages designed exclusively for MSMEs.