Capex Decision: Term Loan, Lease or Internal Cash?

Buying equipment outright, leasing it, or paying from internal cash can each look attractive on a one-line cost comparison — and each carries a different mix of ownership, tax treatment, cash-flow timing and exit risk. This framework compares all three on the same basis before a rupee is committed.

What management should understand

• Confirm the asset meets a documented operating need with a measurable return threshold before any funding route is chosen.
• Weigh term debt’s cash-preserving effect against its instalments, security requirements, covenants and interest cost.
• Check the lease’s maintenance responsibility, residual-value exposure and early-termination terms under the applicable accounting framework.
• Test whether internal-cash funding would leave working capital or emergency liquidity too thin.
• Rank the three routes on present value, tax treatment, maintenance, flexibility, utilisation risk and downside cash flow together, not on any single factor.

For the connected rule, example or next step, see MSME Machinery Loan Disbursement Delayed: Vendor, Bank and Project-Cash-Flow Checklist.

The five-point control review

Practical example

Implementation workflow

1. Define the asset and the operating case

Set out precisely what is being purchased, the utilisation or order book behind the expected return, and the useful life the business expects from it. A funding comparison is meaningless until the underlying operating case is documented and has an accountable owner.

2. Compare economic return against each funding cost

Set the asset’s expected return against the effective cost of each route: the term loan’s interest and processing cost, the lease’s implicit finance charge, and the opportunity cost of internal cash that could otherwise earn a return or sit as a buffer. The cheapest headline rate is not always the lowest true cost once fees, security and tenure are included.

3. Test ownership, useful life and tax treatment

A term-loan purchase is capitalised and depreciated under AS 10 / Ind AS 16, with both interest and depreciation deductible. A lease is accounted for under AS 19 or Ind AS 116, which changes whether the asset and liability sit on the balance sheet and how the expense is timed. Confirm who owns the asset at the end of the term, and who claims the tax depreciation, before signing.

4. Model the cash-flow and debt-service impact

Lay the instalment schedule, lease-rental schedule or cash draw-down against the business’s existing debt-service and working-capital commitments. Run a base case and at least one downside case where utilisation or contribution falls short — a fixed instalment or rental does not shrink just because revenue does.

5. Assess exit, residual value and flexibility

Check what happens if the asset is no longer needed: loan foreclosure or prepayment charges, the lease’s early-termination and return conditions, or the opportunity cost of cash that is now tied up. The route with the lowest monthly cost is not always the one with the least exit risk.

6. Approve with a post-investment review date

Record the approval, the funding route chosen and the reasons the alternatives were rejected. Set a date to compare actual utilisation and cash contribution against the case that was approved, and treat a material shortfall as a trigger to revisit the financing choice, not only the operating plan.

Action checklist

• Define operating requirement.
• Estimate total project cash flow.
• Compare loan, lease and cash.
• Stress-test utilisation and margin.
• Approve funding and post-investment review.

Evidence to keep

• Capex proposal
• Supplier quotation
• Loan or lease term sheet
• Cash-flow model
• Approval and post-audit

Warning signs

Finin2min takeaway