Managing your Equipment Lease

When asked during an informal telephone survey:  What factor do you consider most important in your practice? the dentists interviewed immediately replied: Quality of patient care and comfort.  When asked:  What are your top practice management concerns?  the majority stated they were most interested in income growth and reduction of expenses.  Several also confirmed that a lack of business training has continued to hinder them throughout their careers. These responses indicate to us that the practice management experts of the Canadian dental industry have much to do.

There appears to be a tendency in dental practice ownership towards purchasing an existing practice rather than setting one up from scratch.   During the process dentists and their advisors may fail to consider the inherited equipment lease obligations in situations where the leases are to be assumed and the payments will carry over with the purchase.  The paid-up capital (equity) inherent in an equipment lease may be overlooked, thus denying the seller his rightful value for assets sold.

We believe many accountants and lawyers may not fully understand equipment leasing.  Accordingly it has become necessary for a qualified, un-biased third party to perform an audit in the majority of practice sales. Unless your advisor has a firm grasp of the leasing industry – which is usually gained by working for a leasing company – he or she may lack the required knowledge of this unregulated, approximately 500 billion dollar (per year) business.  An accounting firm gave us this example:  Their clients decided to lease dental equipment rather than buy. After analyzing the differences, advantages and disadvantages, and due to initial cash flow issues or tax implications, the firm felt that leasing was the best option. However, the decision by the clients (who were dentists) to lease for tax or cash flow reasons was just the beginning of their problems. This is where the lessee (the dentist) or someone involved in the practice, should have fully understood all the terms, conditions, purchase option obligations (including the “Fair Market Value”, end-of-term), and also be able to accurately define and verify the interest rate quoted.  It’s almost a certainty that the interest rate quoted will not appear on the lease agreement.

The following case study outlines such an occurrence: A dentist did not have a copy of his equipment & furnishings lease, despite having already made six months of payments.

He said that the leasing company representative verbally quoted an interest rate of about six percent, over a 60-month term, with a 10 percent buy-out at the end of term, one payment in advance. An audit found that the actual, effective interest rate was a staggering 10.25 percent.

This is what the lease auditor discovered:

  • Quoted Rate: Six percent interest – 60 months, 10% buy-out, one advance payment
  • Quoted Payment: $2,403.45 x 60 payments = $144,207
  • Actual Rate: 10.25 percent – as proven by lease auditor
  • Actual Payment: $2,687.37 x 60 payments = $161,242
  • Discrepancy: $17,035 in additional interest paid over the term

The quotation relied solely upon the use of “rate-factor” method of calculating lease payments and when the equipment order was modified at the last minute, a common occurrence, the payments changed and that’s when the confusion began.  (Refer to my column “How to Successfully Manage your Equipment Lease” in Ontario Dentist, September 2002) for detailed instructions on how to invert the rate factors into the interest rate.)

Before signing a new lease, for any amount of equipment, no matter how small it may appear, insist that the actual, effective interest rate quoted be put in writing, and, if necessary, confirm it with a third party.

This is only one example of how leasing may add to the overall cost of running a practice.  Imagine the costs to those dentists who have leased tens of thousands of dollars of dental equipment over the years.  How much interest did they pay out?  Did they know the true, effective interest rate while leasing?  What is your equipment lease costing you right now?  Are you sure?

Ontario Dentist  – April 2004