Finance vs Operating Lease: What to Choose
In the business industry, leasing is essential. New businesses have limited resources and owners may not want to spend a huge amount acquiring assets initially. Therefore, leasing is the best option because it allows business owners to lease assets when they need them. Leasing can essentially be of two types namely, financial lease and operating lease. If you cannot decide which one you should choose between Finance vs Operating lease, this guide will help you gain insightful detail on both leasing options so that you can make the best decision.
What Is A Financial Lease?
A financial lease refers to the lease type where both the return and risk get transferred to the business owner or the lessee when they decide the asset they want to lease for their business. It is a commercial contract in which the lessor lends assets to a lessee for a long period with the inclusion of periodical payments. In simple terms, it is a leasing option for a long-term basis and is also called a loan agreement. It is mostly used to lease equipment for its functionality and the majority of its useful life and has an end of the term balloon. Once the lease comes to an end, the lessee can buy the ownership of the assets if they receive a successful offer to buy the same.
What Is An Operating Lease?
Operating lease refers to the lease type in which the return and risk are not transferred to the lessee but stay with the lessor. It is a commercial contract in which the lessor lends assets to a lessee for a short period and the lessee has to make periodical payments for the same. It is an Equipment lease agreement for a short-term basis and is also called a rental agreement. An operating lease is used to lease the asset for half of its useful life and once the lease period is over, the lessee can return the assets to the lessor.
Operating Lease And Financial Lease: Key Differences
There are many differences between an operating lease and a finance lease and the major features that differentiate these two leasing options are as follows.
1. Ownership
In an operating lease, the asset’s ownership remains with the lessor during and after the agreement term whereas, in a finance lease, the ownership of the assets is transferred to the lessee by the lessor once the lease term comes to an end.
2. Term Of Lease
A finance lease allows business owners to lease assets for a long period whereas, in an operating lease, the lessee can lease assets for a short period. Periodical payments must be done in both the leasing options.
3. Maintenance Of The Assets
In a finance lease, the asset needs to be taken care of and maintained by the lessee whereas, in an operating lease, the assets are maintained and taken care of by the lessor. Therefore, in a finance lease, the responsibility of managing the assets falls entirely on the lessee.
4. Risk Of Obsolescence and Cancellation
In a finance lease, the lessee is responsible for the risk of obsolescence and cancellation. In an operating lease, the lessor or the Equipment leasing companies are responsible for the risk of obsolescence and cancellation.
5. Tax Advantage
In a finance lease, the lessee is allowed to deduct expenses such as depreciation and financing from the tax. In an operating lease, the lease rent can be deducted from the tax.
6. Purchasing Option
In a financial lease, the lessee receives an option to buy the assets when the lease term is over whereas, in an operating lease, the lessee does not have a purchasing option.
7. Balloon Or Residual Option
In a finance lease, the lessee receives a balloon or residual option to purchase the assets at a specific price and the guidelines for the same are set as per the ATO asset guidelines whereas there is no balloon or residual option in an operating lease.
Should You Choose An Operating Lease Or A Finance Lease?
When it comes to leasing options, business owners are always confused if they should opt for a finance lease or an operating lease and the answer for the same ultimately boils down to your needs. If you do not want to handle many administrative responsibilities and want Aircraft financing for the short term, you can opt for an operating lease. A finance lease comes with more administrative requirements and you might have to face some resale risk as you must reach the balloon amount before the lease agreement ends. Therefore, if you can handle this responsibility and want to lease for the long term, you can opt for a finance lease.
Final Thoughts
There are a lot of factors that differentiate an operating lease and a finance lease. Before you choose one, be sure to go through all the above factors thoroughly and use an Equipment lease calculator to determine which leasing option suits your needs the best.