Once you have made the decision to acquire a new piece of medical equipment for your practice, you will be faced with deciding how to pay for it. You will be in a much better position if you have already put some thought into this and discussed it with your accountant and financial manager or consultant. Even if you have the cash available for the purchase, there are several other things to onsider when determining the best option for how to pay for the equipment. Financing the purchase with a loan or on a lease can benefit the financial health of your business through cash flow management and income tax savings.
A better return on investment
New equipment, like a new car, loses value as soon as you buy it. You have paid full price yet have not received any value or any revenues from it. Financing the equipment allows you to pay for it month-by-month as you are realizing the value it provides to you. This results in a more balanced relationship between your expenses and your revenues.
Choosing between financing with a loan or a lease
Start by comparing interest rates. A lower interest rate must be cheaper and therefore better for you, right? That is not always true, and the lack of a proper understanding about what interest rates mean can make such comparisons misleading.
Interest rates are meant to reflect the level of risk involved, and that risk is shared between you and the financial institution. Lower risk for the financial institution means higher risk for you, and vice versa. You can see the effect of this when you compare a variable rate and a fixed rate.
- A variable rate is very low risk for the financial institution because they can just raise the rate when they want. It is you who are carrying the risk of a rate increase, but you can eliminate that risk by paying a higher fixed rate.
- In return for receiving this fixed rate, you are protected from rate increases and you have more stability for your financial planning. Interest rates are currently at historic lows, with speculation circulating over when the first rate increase will happen, so now is a great time to choose a fixed rate.
Another common misconception about interest rates is the belief that all rates represent the same thing. Today, interest rates for a lease are almost always higher than the interest rate for a loan, and few people understand that one reason for this is that the interest rate on a loan (the loan rate) is applied differently than the interest rate on a lease (the lease rate).
When using a loan, you are borrowing to pay the full price including all sales taxes. For example, when you buy an X-ray machine that costs $100,000 plus tax, you will also be paying the 5 per cent GST and 7 per cent PST in BC, so you will actually borrow $112,000. The loan rate is then applied to $112,000, and no sales taxes are added to the monthly loan payments. When you lease new equipment, the lease rate is applied to the pre-tax price of only $100,000, with the sales taxes added to the monthly lease payments.
So how does one compare a 3 per cent loan for $112,000 with a 5 per cent lease for $100,000? By looking beyond the interest rates and understanding how much it will actually cost you.
Income tax write-offs and benefits
The cost of new equipment is a tax deductible expense for your business. However, buying the equipment (with or without a loan) and leasing the equipment have very different effects on your income taxes.
When you purchase equipment, you can deduct 10 per cent of the purchase price in the first year, then 20 per cent of the remaining balance in each subsequent year. The yearly interest charged on a loan is also tax deductible. It can take more than 10 years to deduct the full cost of the equipment and receive those tax savings.
When you lease equipment, you are able to deduct 100 per cent of the value of your lease payments each year. This means that you will deduct the full cost of the equipment over the term of the lease, which can be as short as three years, and you will receive the tax savings as soon as possible.
When you take the total cost of all your payments and subtract the value of your income tax savings, you will see the actual net total cost of financing. We can apply this concept to the X-ray machine example with a five-year financing term:
|Total amount financed||$112,000||$100,000|
|Loan or lease rate||3%||5%|
|Monthly payment (tax incl.)||$2,013||$2,105|
|Total payments (60 months)||$120,780||$126,300|
|Tax deductible expenses||$79,462||$126,300|
|Value of tax deductions
(est. 15% tax rate)
|Net total cost of financing||$108,860||$107,355|
While the loan has a lower interest rate and monthly payment, the lease provides greater tax savings and a lower total cost over the five-year term.
There are many other aspects to consider when choosing between a loan and a lease. Some lenders will require that you make a down payment, put up security or collateral, or sign a general security agreement which can put your personal assets at risk. Most leasing companies provide 100 per cent financing with no down payments or security, as the only security required is the new equipment itself.
It is common to find loan or lease agreements with hidden charges, such as administrative set-up fees, an extra charge for every invoice paid on your behalf, or a yearly fee for providing you with the documents necessary for year-end financials. These extra charges effectively disguise your actual total cost without increasing the interest rate. It is important to read the terms and conditions on the agreement contract and explicitly inquire about any extra charges.
MediCapital supports you
If you want to finance the purchase of equipment for your medical practice in Canada, MediCapital is the financing company that you need. Discover our financing services to healthcare professionals and benefit from our expertise and advantageous services.
Do not hesitate to contact one of our offices in Canada. Contact us
By Graeme Scott