What is total cost of ownership (TCO)?

Start with the acquisition costs: purchase price, delivery, installation, configuration and training. Add the financing costs, such as interest, establishment and lease administration fees, and any balloon payment or residual you will have to cover. Then add the operating costs for each year: fuel or electricity, consumables, licences, servicing and spare parts, insurance, registration and warranties.

Tax changes the picture too. Depreciation deductions, the instant asset write-off and the timing of GST credits (upfront on a purchase, on each instalment under a lease) all affect the real cost. Finally, include the hidden costs of downtime, lost productivity and system integration, then subtract what you expect to get back when you sell or trade in the asset at the end of the period, less any disposal or decommissioning costs.

Define the period, say three, five or seven years, and whose perspective you are taking: purchaser or lessee. List every cash flow, separating the upfront amounts from the yearly ones and treating resale proceeds as a positive flow. For a quick screening, add them all up: acquisition cost plus each year's operating costs, minus the residual at the end.

When the timing of costs matters, discount each future amount to present value using your business's cost of capital, and test a range of discount rates to see how sensitive the result is. Converting the present value into an equivalent annual cost lets you compare options with different lifespans. Whichever method you use, document the assumptions and run best, base and worst cases on the inputs that move the answer most: fuel or energy prices, the residual value and the discount rate.

Leasing and buying spread costs differently, so TCO is the fairest way to compare them. Include the financing charges and fees on each side, the tax treatment (interest plus depreciation when you own the asset, deductible rentals when you lease), the effect on your balance sheet and cashflow, and who carries the residual risk if the asset sells for less than expected.

Watch for unequal scopes: some lease rentals include servicing or insurance, so add the same items to the buy option before comparing. Read the end-of-term conditions as well, since purchase options, return conditions, excess-wear charges, termination fees and CPI-indexed increases all belong in the numbers.