In the complex world of business finance, understanding the key distinctions between operating and finance leases is crucial. Do you know the difference between these two common lease types?
This article delves into the world of leasing, shedding light on the intricacies of each and helping you make informed decisions about your company’s assets. Whether you’re considering leasing a forklift truck or a printer, this guide demystifies the concepts of finance and operating leases, providing insights into their benefits, risks, and how they impact your bottom line.
How does leasing differ from hire purchase?
An SME can buy an asset in small instalments while making use of it with hire purchase and once the repayments are finished you own the asset.
With leasing you don’t automatically own the asset outright. When the set and agreed leasing period comes to an end, you may have an option to buy e.g. the machinery. Alternatively, you could start a new lease arrangement with a different, perhaps updated truck or van.
If your equipment, asset or machinery breaks down or is replaced by a newer model, then the leasing company may fix or update it. In addition, the leasing company may offer some kind of support for the asset e.g. servicing.
One word of caution: make sure you read the terms and conditions of the lease carefully. Some agreements carry early termination fees.
What are the two different types of leasing?
Operating lease and finance lease. Let us start with a finance lease and use a forklift truck as an example.
What is a finance lease?
Think of finance lease as a kind of loan. It’s an arrangement where a business pays to use an asset for the maximum extent of its economic lifetime. With a finance lease, the risks and rewards associated with, for example, a farm tractor, belong to the agricultural leasing organisation. The lessee is considered the owner of the tractor and it appears on the balance sheet. Whilst you will usually benefit from depreciation for tax purposes, you will not be eligible for Capital Allowances.
What is an operating lease?
With an operating lease, the company leasing a printer – i.e. you – does so for a term that is less than its economic life. Think of an operating lease as renting the printer. All the risks and rewards associated with asset ownership remain with the lessor, not you and at the end of the lease, you will no longer be able to use it. Repayments are treated as operational expenses and the printer does not appear on the company’s balance sheet.
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