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Today’s topic is equipment leasing and the “Evergreen Clause.”

If leases weren’t bad enough already, most leases have a little trick in them called the “Evergreen Clause.” This clause can substantially increase the rate of return for the lessor, and at your expense.

Unlike a loan which terminates by itself when you make the last payment, most leases require that you give written notice to terminate.  If you don’t give timely notice, the lease will automatically renew for whatever term is stated in the lease.  This automatic extension is referred to in the leasing industry as the Evergreen Clause.

In lease contracts by more reputable lessors and most major banks, the notice period will be short, such as 30 days before the lease ends, and will renew for a one-month period.  But the less reputable lessors will extend the time periods in the Evergreen Clause, which can cause you to be stuck making many additional payments on a fully depreciated asset.

The worse lease I ever saw was for a security system.  The lease agreement stated that unless notice was given during a one-month window between 6-7 months prior to the scheduled termination of the lease, the lease would auto-renew for an additional five years!  And by the way, this lease already had an implicit rate of 25% before even getting to the Evergreen Clause.  The evergreen clause in this case effectively caused the lessee to pay for the equipment twice.

I strongly suggest that before signing any equipment lease agreement, have it reviewed by a qualified professional.  By doing this, you can often negotiate these types of clauses out, or at a minimum, make them reasonable.  If you’re stuck with an evergreen clause, make sure you have the termination window scheduled on your calendar.  This will allow you to give timely notice of your intent to terminate the lease.

To learn more about leases, visit our video library at www.cfooutsource.com.

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Today I’m going to show you how to calculate the implicit rate of interest on lease by using a loan amortization program.

The program that I use is called T-Value, and can be purchased at www.timevalue.com for about $150.  Before running the program, you need to determine the dates and amounts of all payments.  This includes the initial deposit payment (which is usually first and last), the amount of each monthly payment, the lease termination charge at the end of the lease, and any other scheduled payments.  If there is a purchase option at the end of the lease that can be determined, you will want to run a separate iteration to cover that possibility as well.

In this example we are assuming the following facts:

* Date of Purchase  = 1/1/2011

* Lease term = 60 months

* FMV of equipment = $40,000

* Monthly payment = $1,000

* Due on signing = First and last = $2,000

* Monthly payment of $1,000 for 58 months

* Lease termination fee = $500

First, we give the schedule a name: Lease #1. Input the compounding period as monthly, which we can be entered from the drop down menu.  For Nominal Annual Rate, enter “Unknown.”  This is amount will be eventually be calculated by the program, and is the implicit rate in the lease.

Next, put in our cash flow.  On line 1 we call the event a “Loan” and enter the date of purchase as January 1, 2011, along with the FMV of the equipment, which is the same as the cash purchase price.  In this case the FMV is $40,000.

On line 1 we enter our first cash payment, which in this example is first and last payment, totaling $2,000.  This happens at the inception of the lease, so the date is also January 1, 2011.

On line 3 we enter the monthly payments and the fact that there will be 58 of them, starting on February 1, 2011.  Remember, there is a total 60 payments of $1,000, and the first two were made at the inception of the lease.  So payment #1 and #60 have already been made.

On line 4 we enter the lease termination charge of $800, and the date of the termination of the lease, which is January 1, 2016.

Now that all of cash flow information is entered, we click the calculate button.   The program now tells us that the implicit rate is just over 19%.

If you intend to purchase the asset at the end of the lease, this may be a problem in trying to determine the implicit rate.  This won’t be a problem if the purchase option has a fixed dollar amount.  All you do then is simply add the purchase option price to the termination fee, then click calculate to determine implicit rate.  But if the lease says that you may purchase for FMV, you will have to estimate this amount, and understand that if you’re wrong, it will affect the implicit rate.  But some leases give no criteria as to how to determine this amount, other than stating that it will be determined by the lessor.  Understand that if this is the case, you are completely at lessor’s mercy.

To learn more, visit our video library at www.cfooutsource.com.  Also, to see a video demonstration of the use of the T-Value program, click here.

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Today we’re discussing what goes into determining the actual cost of leasing.

The actual cost of leasing can be incredibly deceiving.  Unlike many consumer transactions which require disclose of Actual Percentage Rates (also known as APR), a lease, by its form and nature, does not have an official interest rate.  But, by the substance its nature, most equipment leasing is actually a financing arrangement in disguise.  And as such, all equipment leases have an implicit rate of interest that can be calculated and compared to other financing arrangements.

Many people who sell leases will often quote something called a “lease factor” percentage, and deceptively present this percentage as if it were the implicit rate of interest in the lease.  Nothing could be further from the truth.  The lease factor is simply the calculation of the lease payment as a percentage of the fair market value of the equipment at the inception of the lease.  In other words, the lease factor might be 5%, but the implicit rate of interest, which is your real cost of money, may be three time that amount or more.

The true interest rate can be computed using a loan amortization program, and will consider the timing and amount of each payment.  Sometimes the implicit rate of interest will be fair, but sometimes it will be astounding!  Most are in the range of 12-20%, but I have actually seen them as high as 50%.

To learn how to calculate the implicit rate of interest on a lease, visit our video library at www.cfooutsource.com.

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Today, I’m giving you an overview of equipment leasing, starting with the benefits, followed by the potentially substantial downsides.

To lease or not to lease.  That IS the question!  Generally speaking, I advise my client to never lease to have to, or unless they a compelling reason.  And if they have to lease, make sure the lease is thoroughly reviewed by a competent professional.  This will at least allow them to understand what they are getting into.

Why would a business have to lease?  The reason would be because they have no other options.  This may be because they don’t have the cash to make a down payment on a standard loan, or they aren’t in a financial position to qualify for a loan.

That being said, there may be some compelling reasons to lease.  I have a client who finances a fleet of trucks through leases, and his primary motivation is to keep activity off of his personal credit report.  This qualifies as a good reason for leasing.  Another good reason is that sometimes, large, reputable vendors will provide excellent leasing programs in order to sell their products.  But even these programs may have some hidden traps, which is discussed in other videos.

Now for the downsides: 1) It can be difficult to determine the actual interest rate.  (See our video library for a demonstration of how to determine the actual interest rate).  2) Equipment leases are difficult and costly to get out of.  Unlike a loan, where you can get out simply by selling the equipment, with leases you are potentially stuck for the entire term.  3)  Many leases have a built-in trap that can potentially cost you a lot money.  That trap is referred to in the industry as the “Evergreen Clause.”

There are many other considerations in leasing equipment, which include whether or not the lease liability needs to be disclosed on your balance sheet.  To learn more about leasing, check out our video library at www.cfooutsource

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Today’s topic is an introduction to series on the topic of Equipment Leasing.  To view blog as a video, click here.

I once met a consultant who was in the business of helping companies get out of bad leasing arrangements.  Prior to that, he was in the equipment leasing business.  He said he got out of it because he couldn’t sleep at night.  And as he and I worked together to get to help a billion dollar company unwind some of their bad leases, I came to learn exactly what he was talking about.

Equipment leasing is buyer beware, liaise faire, unregulated capitalism at its worst.  Don’t get me wrong, there are honest leasing companies out there who cut fair deals, and are straight up about what is going on.  The good lessors are generally reputable banks and high-volume specialized equipment manufacturers whose long-term existence depends upon repeat business.  But there are others out there who would figuratively eat their young, and their main objective is to get you into a leasing arrangement that bleeds the profits of your business directly into their pockets.

You don’t have to be a small business to be at risk.  Some of the worst deals I’ve seen were made by large companies who had the resources to properly analyze leases before getting into them, yet for various reasons, didn’t do it.

We’ve just added a crash course on leasing to our video library that is designed to help business people avoid the pit falls of bad equipment leasing, and to give guidelines as to when leasing may be appropriate.  To learn more, visit our website at www.CFOoutsource.com.

The Debt-to-Equity ratio is a measure of a company’s financial leverage, and is computed by dividing Total Liabilities by Total Equity.  The higher the number, the greater the financial leverage.  What is financial leverage?  Financial leverage has to do with the amount of return on investment that can be generated from a stated amount of equity.  The greater the debt-to-equity ratio, the greater the leverage, and potentially the greater the return on investment.

For example, let’s say you bought a house for $1M and paid cash.  If the house increased in value up to $1.1M, you would have made 10% on your equity investment of $1M.  But if instead, you had only put down $100K and borrowed  $900K when you bought the house, the $100K increase in value would represent a 100% return on your equity investment of $100K.

But leverage is a double-edged sword.  It’s great when property or companies are increasing in value, but leave little margin when they decrease in value.  If the value of the house drops below $900K, the owners equity would be wiped out, and the bank would be left holding the bag.  This is why lenders don’t like to see large debt-to-equity ratios.

What a good debt-to-equity ratio is will depend on many factors.  For example, public companies tend to have lower debt-to-equity ratios than do private companies.  Many start-up companies, especially those that are high-tech, tend to have low debt-to-equity ratios due to high start-up costs that are usually funded by equity investors.  Many established privately owned companies that have large receivable and payable balances will often have high debt-to-equity ratios, because the large payable balances will skew total liabilities.

If your bank has loan covenants that require that the debt-to-equity ratio not exceed a certain number, it’s imperative to have a financial model business plan that predicts the debt-to-equity ratio at future dates.  For more information, visit our video library at www.CFOoutsource.com.

The Statement of Cash Flow is one of the three basic financial statements. Like the Statement of Operations, the Cash Flow Statement describes changes during a period of time, such as a month, a quarter, or a year. Specifically, it describes changes in cash balances during the period. The Statement of Cash Flow can be somewhat of a dichotomy in that it is at the same time the easiest and the most difficult statement to understand.

It’s easy in that it clearly lays out an explanation of how the cash balances changed.  It divides the changes of cash into three categories: Operations, Investment, and Financing Activities.  The Operations section shows how cash was generated from the business operation.  The investing activities section shows the amount of cash that was used to purchase assets, such as land and equipment, as well as cash that was received from the sale of assets.  The Financing section shows financing activities, such as cash that was received from borrowing money, as well as paying money back.

The section of the cash flow statement that is the most difficult to understand is the operating section.  This is because it is essentially a reconciliation of accounting  based on the accrual method to the accounting based on teh cash method.  In order to make this happen, non-cash expenses, such as depreciation or the loss on a sale of an asset, have to be added back to net income.  Additionally, changes in accounts that are meant to accommodate the accrual basis of accounting have to be added or subtracted.  These accounts include Accounts Receivable, Inventory, Accounts Payable, Accrued Expenses, and other accrual related accounts.

At the end, we have a complete reconciliation of how cash balance changed during the period.

Forecasted Statements of Cash Flow are essential to include in your business plan because bankers and investors want to know exactly how you intend to generate cash.  This statement gives them the ability to analyze the reasonableness of your model.  Remember, the Statement of Cash Flow is only one of the three basic financial statements, the other two being the Balance Sheet and the Statement of Operations.

For a simple understanding of the other two basic financial statements, visit the video section of our website at www.CfoOutsource.com.

The Statement of Operations, aka the Income Statement, is one of the three basic financial statements. It’s a statement that provides details of how much your company made over a stated period of time. Unlike the Balance Sheet, which is a snapshot of a very specific point in time, the Statement of Operations describes activity over a stated period, such as a month, a quarter, or a year.

It ultimately tells the reader the amount of the net income of the company, which is the amount the company made during the period.  In addition, it breaks down the components of net income.  These components include Revenue, Cost of Sales, Gross Profit, Operating Expenses, Income form Operations, Other income, Income Taxes, and finally, Net Income.

Businesses that have good financial information will produce a Statement of Operations at least once per month.  After it is prepared, it always ties to the Balance Sheet by way of reconciling Equity before and after the events that generated the Net Income.  As a simple example, if the Balance Sheet on first day of the year showed $400,000 in Equity, and during the year the company had $275,000 in Net Income, then equity at the last day of the year would be $675,000.

Forecasted Statements of Operations are essential to include in your business plan because bankers and investors want to know exactly how you intend to generate income.  This statement gives them the ability to analyze the reasonableness of your assumptions.  Remember, the Statement of Operations is only one of the three basic financial statements, the other two being the Balance Sheet and the Statement of Cash Flow.

For a simple understanding of the other two basic financial statements, visit the video section of our website at www.CfoOutsource.com.