How do Finance and Operating Lease Complement Each Other

 

 

Whenever a businessman plans to start a project, the main subject of concentration belongs to funding. The investors do have the blueprint ready in their minds, but mostly they lack the resources to fulfil it. Hence, they adhere to either leasing or financing. Once the finances are available, they can now invest in their business and follow the specific mode of repayment.

In this write-up, we have discussed these accounting methods and the two types of leasing.

What Is Leasing?

Leasing is an accounting method where the lessor purchases the asset on the lessee’s behalf. The lessee can use the asset for a given period, paying monthly rentals to the lessor.

Lease is divided into two categories: financial lease and operating lease. Please find the fundamental differences between these two types of leasing methods.

Differences Between Financial Lease and Operating Lease

The main difference between the two is that in a financial lease, the rights of the asset are transferred entirely to the lessee. The lessee shall carry out, any maintenance that the asset requires. The lessee must pay rental payments to the lessor, by which the lessor shall recover the amount paid for purchasing the asset.

In an operating lease, the rights of the asset are retained by the lessor. The lessor must execute, any maintenance of the asset. Also, the lessee’s rental payments do not sum up the actual expenditure of the asset. It excludes the residual value that the lessor expects to receive once the asset is resold at the end of the contract.

Regarding the time, the financial lease is a long-term agreement, whereas the operating lease is for a much shorter period. At the end of the contract, the financial lease allows the lessee to sell the asset or return it to the lessor, but in the case of an operating lease, the lessee must return the asset to the lessor at the end of the contract period.

What Is Financing?

Financing an asset involves purchasing the asset by the user, not by the financing company. The financier pays the user the amount required to purchase the asset. The user buys it and pays the financier installments to repay the loan. The installments can be monthly, quarterly, or yearly, depending on the agreement.

Finance vs. Operating lease

In finance, the user purchases the asset by taking the funding from the financier. On the other hand, the lessor purchases the asset in an operating lease and lets the lessee use it.

In finance, the user is the asset owner. He can make any changes without being answerable to the financier. On the other hand, in an operating lease, all asset rights are reserved with the lessor. Here the lessee cannot modify the asset.

At the end of the contract period in finance, the user can choose the next course of action. But in an operating lease, which has a much smaller contract period, the lessee must return the borrowed asset to the lessor at the end of the agreement.

By viewing the above points, it is clear that financing and operating lease are entirely different notions, thus complementing each other in any business.

 Equipment Leasing and Financing

Based on the globally growing infrastructure, various types of equipment are required to proceed with the development processes. Naturally, a businessman wants to utilize the latest and most advanced equipment. But the same requires a large sum of money, which they generally avoid paying at one go, in the beginning.

Equipment leasing and equipment financing are two ways to arrange the funds. However, the main differences, as stated in the previous section, apply to equipment as well.

In the case of equipment leasing, the businessmen do not own the equipment. They, in a way, borrow it from the lessor and repays monthly rentals. The process is for a short period, ending in which the businessman has to return the equipment to the lessor. An equipment lease agreement documents the decisions taken between the small business owners and the equipment leasing companies in the contract.

The lessee needs to pay the lessor monthly for the leased equipment. The payments can easily get calculated using a tool known as the equipment lease calculator. This calculator involves variables such as the current value, residual or resale value, the rate of interest, etc.

If the businessmen opt for equipment financing, they would have ownership of the equipment. At the end of the contract, the decision about retaining or selling the equipment lies in their hands. The role of the financier is not only to supply the funds at the beginning of the contract, which the business owner can repay by a suitable method.

Equipment financing is often considered better due to the ownership rights. Apart from equipment, vehicles also employ the financing method, such as aircraft financing.

So What We Understood About Finance and Operating Lease Complement Relationship?

Well, being the exact opposite of each other, finance and operating lease complete each other’s pros and cons. The business owners can study these two accounting methods cautiously to take the final decision about arranging the funds for their equipment.