When it comes to acquiring essential equipment for your business, leasing can be a cost effective and flexible solution. Through leasing, businesses can secure and use high-value equipment without the upfront costs. However, not all leases are the same, and it’s essential to understand the different types to make the best decision for your company. Two main forms of leasing are finance leases and operating leases, both offer different benefits.
In this article, we’ll explore what leasing is, the differences between a finance lease and an operating lease, and key considerations to keep in mind when choosing a lease.
What is the definition of leasing?
Leasing is a contract between a lessee (your business) and a lessor (the leasing company). Businesses use leasing to access equipment or property for a set period, making regular payments to the leasing company. This alternative to buying assets outright helps preserve cash flow for essential operations by avoiding large upfront costs.
What is a finance lease?
Under a finance lease, a business makes regular payments to secure an asset over a long term period. The business assumes most of the risks and rewards associated with ownership of the asset. They are responsible for maintaining it, insuring it, and covering any related costs.
Key features of a finance lease include:
- Full access to the asset: While the business doesn’t own the asset, the lease is structured so that it has full access to it, and is responsible for most of the risks and costs involved. This means that it’s unlikely to have restrictions such as mileage limits.
- Option to purchase: At the end of the lease, businesses have the option to purchase the asset for a nominal fee, often referred to as a "balloon payment."
- Balance sheet entry: Finance leases are usually recorded as assets and liabilities on the company’s balance sheet because they are considered a form of borrowing.
Finance leases are particularly useful for businesses that need access to expensive equipment or vehicles, but may not have the capital to purchase them upfront. They are commonly used in industries where long term use of machinery or vehicles is essential.
What is an operating lease?
An operating lease, is a leasing arrangement in which the lessor retains most of the risks and rewards associated with owning the asset. The lessee (the business) simply pays for the use of the asset during the lease term and typically has no option or obligation to purchase the asset at the end of the lease.
Key features of an operating lease include:
- Shorter term: Operating leases tend to be for shorter durations and cover only part of the asset’s useful life.
- No ownership: The business won't take on the risks of ownership, such as depreciation or maintenance. The lessor remains responsible for the asset.
- Flexibility: As operating leases are short term, they enable a business to upgrade or change equipment more frequently.
- No option to purchase: At the end of an operating lease, the asset typically returns to the lessor, with no option to purchase.
Operating leases are popular in industries where technology changes rapidly, such as IT, or where equipment may become outdated quickly. They can be used by businesses in these industries as part of a strategy to stay ahead of competitors and provide the best services to their clients.
Choosing the best suited option for your business
Consider the following key points when choosing between a finance lease and an operating lease:
Duration of use
If your business needs the asset for a long period and wants to have the option to own it, a finance lease may be the better option. If your business only needs the asset temporarily or expects it to become out of date quickly, an operating lease may be more cost effective.
Ownership options
If your business might opt to keep the asset after the lease period, a finance lease gives that option. If not, an operating lease allows for flexibility without the long term commitment.
Maintenance and risks
Consider how much control your business needs over the asset. If your business can handle maintenance and wants more control over the asset, a finance lease may be the right choice. Otherwise, opt for an operating lease that offers the advantage of leaving most of these responsibilities with the lessor.
Both finance and operating leases have benefits Understanding the terms and implications of each will help you make an informed decision that aligns with and serves your business goals, financial situation, and long term plans.
Applying for a lease
If you’re considering leasing an asset for your business, you can explore a range of choices with Capitalise. Working with a panel of 100+ UK lenders, we can help you to find a lender best suited to your needs. Just sign up and search for funding to get started, or use our loan calculator to see how much you could borrow.
