Purchasing vs. Leasing Lab Equipment

Written by on December 5, 2011 in Practice tips - No comments

By Libby Knollmeyer B.S., MT (ASCP)

The selection and acquisition of equipment and consumables for the laboratory is one of the major responsibilities of the lab manager. Although the means of acquisition is not always left to the manager to decide, it is still necessary to understand the various options available: 1) cash purchase, 2) lease, and 3) reagent rental. All have pros and cons attached to them, but to understand which might best suit the laboratory’s needs, it is necessary to understand what each is.

Purchase is accomplished by offering money and obtaining ownership of the product. The money can be from liquid cash assets of the lab or practice, or by borrowing money from a financial institution, whether by a loan or a line of credit. The end result is outright ownership of the goods after all loans have been repaid. Outright purchase usually carries the lowest interest rate for a loan, but the capital equipment must be depreciated over a period of time, generally five years for laboratory equipment, and appears on the balance sheet as a long term debt. If assets are liquidated in order to purchase capital equipment, the loss of capital gains for those assets must be factored in against the lower interest rate available for a loan versus a lease.

A lease can be one of two types: Fair Market Value (FMV) or Capital. In a FMV lease, at the end of the lease ownership is dependent on the lessee paying a “fair market value” for the commodity, generally 10% – 15% of the retail price of the goods. A capital lease is also sometimes referred to as a “dollar buy-out lease” because at the end of the term of the lease, the lessee can purchase the commodity for $1.00.  As one would expect, the interest rate on a FMV lease is less than on a capital lease. Ownership is optional at the end of the lease period, but is generally a given for a capital lease because there would be no reason to opt for a capital lease with the higher interest rate if ownership at the end of the lease was not desired. Capital leases can be deducted for tax purposes like purchases. One of the most attractive options for leasing capital equipment is there is no capital outlay required to acquire the equipment. Another is that service can be added to the lease payment as an interest-free “pass through” whereby the leasing agency passes the service payment on to the contracted service provider on a monthly basis, eliminating the large service contract which would otherwise come due annually after the warranty has elapsed. And, unlike a purchase, a lease can be considered a tax-deductible overhead expense.

A reagent rental agreement is arranged by the manufacturer or distributor of the equipment being acquired. The cost is usually based on a cost per reportable test (CPR), but sometimes is based on total test count. The difference is that in a CPR arrangement, calibrations and controls are not counted in the pricing structure, while in a total test count arrangement, all tests are counted and charged. The price paid per test covers the cost of the instrument, service, reagents, and consumables for the term of the agreement, but there is no ownership at the end of the agreement. This option, like leasing, offers the use of capital equipment, reagents, and consumables without capital outlay. It also eliminates the need to contract for service annually after the warranty has elapsed because service is covered in the CPR. For labs with very large volumes, highly competitive CPR rates can be negotiated, making this an attractive option for reference labs. However, the CPR is calculated to cover the cost of the equipment and service in addition to reagents and consumables, so at the end of the term of the agreement, the instrument has essentially been paid for but there is no ownership. If the reagent rental agreement is renewed without renegotiating the terms, the equipment could be paid for more than once without ever achieving ownership. Successful reagent rental arrangements require the lab operator to have an accurate estimate of test volumes over the length of the agreement. Failure to estimate correctly could mean paying for tests which are never run, or losing the lower cost per test advantage which generally accompanies growth.  However, for small labs with no capital funds available for instrument purchases, this option might allow the lab to do in-house testing which otherwise might not be available.

Which option will be used to acquire capital equipment is always a financial decision, and often not left to the laboratory manager but made instead by the practice administrator, or hospital or reference lab CFO.  But the lab manager can add significant insight into the selection of financial methods. The information that should directly affect the decision and can best be provided by the lab manager is whether or not ownership is desired (a function of how rapidly the technology is changing), and whether or not service is included or will be charged in addition.

Ownership can be a two-sided coin. Where technology is volatile and rapidly changing, ownership of highly technical equipment can be a burden. If the technology is going to evolve and change to the extent that the equipment is out of date by the end of the term of the loan or lease, ownership is not always desirable, unless the dated equipment could be used as a backup instrument. That being said, if the technological changes are not going to affect the way the lab operates or the tests that can be offered, then the volatility is not a factor and ownership would be preferable.

Service contracts are expensive (generally about 10 percent of the retail purchase price of the instrument) so if leasing provides additional warranties or field service offered by the lessor, a lease can be a more attractive option than purchase. In reagent rental agreements, service is provided as part of the cost per reportable test.

Other considerations that will affect the choice of purchase, lease, or reagent rental are cash flow and the need to achieve the lowest outflow of cash, the flexibility of leasing terms and their ability to meet the lessee’s needs, and whether or not the balance sheet for the organization strongly prefers not showing debt (an operating lease is not considered a long term debt).

Ken Lee, Partner in Hatteras Venture Capital, believes the message should be that leasing is a better choice in some circumstances, especially where cash flow is an issue, technological advances are rapid and constant upgrading is necessary, extended warranties are offered, and the balance sheet strongly prefers showing no debt.

Dan Melamedorf of Baytree Leasing believes leasing offers a number of advantages over a loan for purchase, including being tax deductible as an overhead expense, not showing up as a long term debt on the balance sheet, an immediate write-off of the dollars spent, eliminating the need to depreciate the equipment over 5 years or more, flexibility, virtual 100% financing options available, and the variety of leasing products available offering customized solutions to the needs of the corporation.  He has provided an example of cash versus lease in the table below.  [insert Cash vs Lease example]

Emmett Kane, Kane Healthcare Solutions, LLC, believes that reagent rental is the best option if the platform is a closed system where the reagents, parts, and consumables are proprietary and alternatives are not available or possible. “Know the component cost breakdown for equipment, service, reagents, parts, consumables, and the cost of money,” he cautions, “and include language in the agreement that protects your costs in the event any component or individual test on the platform menu either temporarily or permanently cannot be performed.”  For leasing Emmett believes like leasing a car, the lab should know what the component costs are for leasing equipment and should know whether or not they want to own the equipment at the end of the lease term.

Mary Pat Whaley, Practice Administrator for a bariatric surgery clinic in Cary, NC, says that her ideas of how best to obtain capital equipment have changed over time. Where ownership was once her primary goal, her goal now is to acquire equipment “with the least amount of pain,” whether the “pain” is cash outlay or maintenance and service. “Put all the pieces together to determine the return on investment (ROI) before making the decision as to how a piece of equipment is to be acquired,” she recommends.

In the end, whether to purchase, lease, or arrange a reagent rental agreement will depend on the specific needs of the organization, its cash on hand, the cost of money, and the way the organization manages its accounting. But the informed laboratory manager can assist in the selection of an option for acquiring capital equipment by providing valuable information as to the rate of change in the technology involved, accurate estimation of test volumes, and comparison of the options presented to her by the vendor.

Article reprinted from ADVANCE magazine

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