In the second edition of CFO Chats, a column by Bill Bosco, president of Leasing 101, Bosco outlines a conversation between a sales person and a CFO that’s considering stopping leasing to improve their company’s earnings before interest, taxes, depreciation and amortization (EBITDA).
Bill Bosco, President, Leasing 101
This continued Monitor column is another slice in the life of a leasing sales person. It is a fictitious sales call between a leasing sales person and a CFO prospect. This could be a face-to-face sales call or a quick phone call to see how the customer is doing and if there are any new problems the CFO is facing or new projects that may spell new business for the lessor.
Since they may only face large financing decisions a few times a year, CFOs don’t usually know the array of leasing products available to them, so sales people need to know how to probe, solve problems and offer the structure that best serves the customer’s needs. Leasing sales people also need to understand corporate finance and financial reporting issues that concern CFOs.
So here we go with our second CFO Chat.
Leasing Sales Person: Good morning, I am the new sales person with BankLeaseCo and would like to talk about financing your capex. How are things going?
CFO: This month I’m financing this year’s replacements for our delivery truck fleet. It is $2 million in size and I am thinking of borrowing to buy instead of continuing to lease.
Leasing Sales Person: Why are you stopping leasing?
CFO: We are trying to improve our EBITDA, and the synthetic lease we were using to finance the fleet is an operating lease, which hurts EBITDA. The lease rent is a deduction from EBITDA, whereas if I borrow to buy, the interest and depreciation are “below the line” for EBITDA purposes. The truck manufacturer’s captive gave us a proposal for a 6% five-year loan with a 20% balloon. Since the new lease accounting rules capitalize operating leases on balance sheet, I don’t see the difference between a capitalized lease versus a loan.
Leasing Sales Person: It’s true that the loan will improve your EBITDA, but the financial reporting treatment of a borrowing to buy will hurt other key measures like return on assets (ROA), return on equity (ROE), earnings per share (EPS) and return on invested capital (ROIC) when compared to the financial reporting impact of an operating lease. The operating lease capitalizes at significantly less than 100% of the asset cost, and its P&L cost is level rather than front loaded as with a loan. You might consider running proforma financials on the two options. I personally favor earnings over EBITDA as a financial measure. If you still think EBITDA is important enough to sacrifice earnings, there is another lease option, namely a synthetic finance lease that will allow you to have control of the trucks through purchase options and should be more attractive from a financial presentation perspective than borrowing to buy. It will not cost you any more, as the financing rates are the same. I can help you run proforma financials on all three options.
CFO: That all sounds like a great idea, but can you explain this synthetic finance lease and its benefits?
Leasing Sales Person: I can’t reveal the full structure unless you hire me, but I can structure a synthetic finance lease to match the average life of the loan proposal. It would capitalize at $1.7 million, or 85.2%, of the cost of the trucks, and the imputed interest and amortization of the asset would be EBITDA favorable below the line. The 14.8% reduction in reported assets versus the loan option will improve ROA and ROIC and should reduce the need to hold the full amount of equity capital to support the assets.
CFO: OK, let’s work together on the comparative analysis. How do I know which lease product is the right one for my company, and how to I get the right product?
Leasing Sales Person: I don’t expect you to be an expert in lease products. We are relationship minded at BankLeasCo and have a full lease product line. There are four basic lease types that deal with financial reporting and IRS tax issues. My goal is to give you advice as well as financing. When you have the time, I would like to schedule a presentation on why companies lease and the benefits of the various lease structures available to you as our customer.
CFO: Great, I will schedule it for next week.
ABOUT THE AUTHOR: Bill Bosco is the president of Leasing 101, a lease consulting company. Bosco has nearly 50 years’ experience in the leasing industry. His areas of expertise are accounting, tax, financial analysis, structuring and training. He was on the Equipment Leasing and Finance Association’s accounting committee from 1988 to 2017 and was chairman for 10 years. He is a frequent author and speaker on leasing topics. He was selected to the FASB/IASB Lease Project working group. He can be reached at firstname.lastname@example.org.
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