Good morning and happy Thursday.
Today’s blog is brought to you by Kubae’s insistence. It was brought on by our being guests of Jeff Taylor with Key Bank at the Portland Thorns match last night. It was our first visit to the Key Box at Providence Park and she fell in love with it. By it, I mean the food and the opportunity to watch the match while also enjoy some interesting conversations with the other guests. It was a great evening and my thanks again to Jeff and the team at Key Bank.
The decision to rent or buy is often a very challenging decision. You would think that it would be pretty logical – I will generate X dollars of revenues (or cost savings) by spending Y dollars on equipment. Sadly, it hardly ever is given that level of scrutiny. Most rent versus buy decisions come down to an emotional “Ownership” decision where I look at the fact I can call it my own instead of admitting to the world I rent.
For you lovers of logic and numbers, I do have a spreadsheet which will help you through this part of the analysis. I also have a spreadsheet (actually it is just a blank workbook) for you to list out and quantify all the emotional reasons to own. If you are interested in my Rent versus Buy spreadsheet, shoot me an email and I will send you a copy.
When asked if a small business owner should rent or buy, My first question is about utilization. How much will it be used over the useful life of the item? There are a few rules of thumbs out there but the one I work with is:
- Rent if used less than 20% of its useful life
- Lease if it is used between 20 and 80% of its useful life
- Buy if used over 80%
An example: A contractor needs a new work truck. It can be driven about 350,000 over 10 years before it starts to run into trouble and should probably be disposed. The contractor estimates she will put on 210,000 miles over a 7 year period. First pass answer is Buy.
The truck is designed to handle about 35,000 miles per year. The contractor will use the truck 30,000 miles per year. This comes out to 85% of the useful life of the truck.
I would not stop there though because the important question is, does it make financial sense? My spreadsheet helps with that as it calculates the Net Present Value (NPV) of the investment in equipment and forces us to think about all the costs of owning the new item. For instance, with a truck (like above) there are oil changes, maintenance, tire changes, axle replacement, etc. that one needs to consider. I also consider potential revenue benefits for the investment as well since in most cases that is the main reason for buying an asset! If all of these items generate a positive value then the decision is supported.
So back to why Kubae suggested that Owning versus Renting would be a good topic for today. First, we lease our condo. When we really do the math on the Rule of Thumb, we only use the space about 62% of the time – since we both work in other offices and we typically spend our alternate weekends exploring; but to be sure we ran it through the Net Present Value calculation. It actually calculated out with a better return on investment for us to lease a Condo rather than purchase it.
By the way, the same for the Subaru that Kubae drives. We put on less than 1,000 miles a month so we definitely fell into that Lease category. We didn’t even bother with the calculation as the answer felt right. Plus we are excited about the changes to automotive technology which will reduce our dependence on driving even more, but that will come in a future article.
Key Bank did the exact same thing when it came to that Box at Providence Park. They knew it would generate more than sufficient revenues to offset the cost and ran it through their own NPV calculation system. Emotionally it might have made sense to invest in that Box but it only happened because it added value to their business. Have you ever wondered why there are no Apple Fields or Intel arenas?
In business, especially in a small business where every dollar counts, I would strongly encourage you to try to take as much emotion out of the Buy versus Rent decision as you can. If you insist on owning it even though all the logic says rent, then purchase it personally (or though a separate LLC) and then rent/lease it back to the Company. If it can generate positive NPV for you that way, then your emotional hunch paid off.
I strongly encourage you to talk with your accounting professional about how to go about buying equipment and other assets for your business. If you do not have an accounting professional or would like a second opinion, feel free to contact me. I offer a free no obligation consultation to help us get acquainted and for you to see if we are good fit.
Have a great day.
Accounting Clarity 