Updated: Nov 10, 2021
As a business-person you know that the world runs on credit. It’s a matter of fact that access to financing is easy and available when times are good. Access to credit can be cheap with a low interest rate. Would you rather pay $50,000 in cash to purchase a business vehicle today or keep the $50,000 and borrow at a 3% interest rate for the same asset?
The question is personal but more often than not, business owners will decide to keep the cash on hand and instead finance large purchases that will help them generate additional revenue for their business. So what does financing large purchases have to do with taxes and accounting? There are some great benefits to unwrap.
For one, all the interest paid by a business towards a financed asset is considered a deductible expense. For this reason, it is critically important to keep track of statements of interest paid. It is imperative to capture every dollar spent as a qualified expense when preparing the tax return.
Another benefit of a financed asset is that you can depreciate the asset over time. (Curious about depreciation? We have another post here about it.) By depreciating the asset, you are receiving a tax deduction over a number of years to offset any income in future years. These tax deductions will help you keep more money in your pocket.
If you purchased the asset with cash, it would be limited to only the cost of the asset as a deduction. By contrast financing an asset allows for the write off of both: depreciation and interest expense.
The flip side of these benefits is that financing assets when times are tough can be an expensive undertaking. If business slows down, you are still liable for payments on the financed asset. If payments are missed or defaulted on, this will negatively impact credit score and future interest rates. Selling financed assets when times are tough can also present problems because the fair market value of the asset may be less than the loan due (ie. being underwater on a loan).
The takeaway...financed assets can help a cash strapped company improve its earning potential and should seriously be considered if the loan terms are favorable for the borrower. If the interest rate is lower than the increase in revenue generated by the asset, financing makes perfect sense. However, if the outlook of business is dim then the decision gets much harder. Speaking with a tax accountant will help you know if your business can weather a downturn.