What’s the difference between a Finance and an Operating LeasePublished on 22nd November 2019 2019-11-22T12:00:00+00:00 - Last update on 13th April 2020 2020-04-13T19:03:29+00:00
Your business needs vehicles, tools, IT and equipment of all kinds. Collectively, they are known as ‘assets’.
Buying all the assets you need with cash means a major capital investment. When it’s a big item, like a van or a machine tool, most firms don’t have the funds available, particularly in the early stages. When you're looking to finance new assets, Asset Finance can often provide the most cost-effective solutions.
Asset Finance covers a number of quite different funding arrangements. For example, Hire Purchase is a simple way to spread the cost of buying an asset, allowing you to pay a deposit plus fixed monthly instalments for an agreed term, which generally lasts between 12 and 72 months, after which the assets become your property.
But there can be sound reasons not to purchase assets at all. It will mean spending capital even is the payments are spread out over a few years. It will also mean a high monthly cost when you are dealing with an expensive item, such as a large machine tool. And it can mean being left with an obsolete or worn out piece of equipment that you have paid good money for – but which will become a liability for your business if better and newer models are available.
In these scenarios, you may prefer to lease equipment. A lease is an agreement conveying the right to use property, plant and equipment, usually for a period of time set out in the contract. The party that gets the right to use the asset is called a lessee and the party that actually owns the asset, but leases it out is called the lessor.
There are some important advantages to leasing over owning in many cases – and there are two main types of lease to consider: Operating leases and Finance leases. The differences could be important for your business.
Operating Leases work much like a rental agreement. You pay a monthly rental charge to use the asset. This means that payments are considered operational expenses and the asset being leased stays off your balance sheet.
Because it works like a rental arrangement, the responsibility of owning the asset can be avoided and maintenance, repairs and registration can remain the responsibility of the leasing company – when something goes wrong, it is up to them to send someone who can fix it for you.
Operating Leases can be ideal for many types of equipment with a limited life that you do not wish to own outright. Vehicles - which deteriorate in condition fast as they are used, and consequently fall in value or depreciate rapidly - may be one area where Operating Leases are preferable. Another area is for technical equipment. Some types of medical and scientific equipment, which may become obsolete in a matter of years (or even months) as better equipment becomes available, may also be suitable for an Operating Lease, as it can allow them to be easily replaced with a new and improved model.
Finance Leases, also known as Capital Leases, can operate more like a loan. In general, a Capital Lease (or Finance Lease) is one in where all the benefits and risks of ownership are transferred to the lessee – the business that uses the asset. This is like financing a car via an auto loan - the car buyer is the owner of the car for all practical purposes but, legally, the financing company retains the legal title.
A Finance Lease, therefore, lets you borrow equipment for a set time but maintenance, repairs and running costs will become your responsibility.
Finance Leases are common with very large assets - aircraft and complete factory plant installations are often provided with a Finance Lease. If you want to set up a complete production line, for example, a Finance Lease could provide the scale of funding required.
With a Finance Lease, the lessor can transfer ownership of the property to the lessee by the end of the lease term. This can mean that the lease contains an option to purchase the leased property at a bargain price.
Which is right for your business?
Both Capital and Finance Leases have their benefits and choosing the option that is right for your business may need some advice. Understanding which type of lease is right for your business might be complicated. You may need to consult your accountant, and you should certainly talk to us at Rangewell.
At Rangewell, we are expert in business funding of all kinds, and can work with you to find the most competitive leasing solution for your business needs. We know all the leading Asset Finance and ease providers in the UK, and we can help you find the most cost-effective provider for your requirements - whatever scale they are.
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